Three Strategies to Avoid Investment Potholes on Your Road to Success
There are three key components to developing a sustainable, long-term investment plan that can help you achieve your financial objectives and sleep well at night on the journey. Investing always involves risk, but a well-disciplined and well designed financial plan can help you avoid some of the potholes that exist on the road to financial success.
Avoid Investment Hysteria
Someone once said that the only thing we ever learn from history is that we never learn from history. When it comes to investing, that seems to absolutely be the case. The bursting tech stock bubble of the1990s and the exploding real estate bubble of the recent years are just the latest incarnations of an age old problem: When investment hysteria sets in, normally rational people make very irrational decisions.
Internet stocks, real estate speculation, ... tulips? In 1593 in Holland we see how the lure of easy riches can create both great financial excitement and financial ruin. A sailor returned from a trip with a new variation of tulip. They sold at somewhat inflated prices right away, but when a non-fatal virus called Mosaic developed vibrant stripes on the tulips, they became perceived to be of great value and a huge market developed for them that created a complete market hysteria. Charles Mackay in his book, “Extraordinary Popular Delusions and the Madness of Crowds,” noted that commerce in Holland ground to a halt as “nobles, citizens, farmers, mechanics, seamen, footmen, maid-servants, even chimney sweeps dabbled in tulips.” One story that came out of the period was of a man invited to a meal at a wealthy merchant's home. The poor man ate what he thought was an onion but was actually a rare tulip and was promptly imprisoned for his mistake on a felony theft charge. Eventually, the craze ended, and the tulip market collapsed and with it the financial fortunes of countless investors. Some things change, and some things never do.
It is important to decide upon a long-term investment strategy that is compatible with your goals,, your risk tolerance, and your time horizon and stick with it. Avoid the hysteria of the latest market fad. Tune out the carnival barkers on the financial news programs hyping the next big thing. Make it your goal to build wealth for the long haul.
Don’t Put All of Your Eggs In One Basket
You have heard the advice all of your life to the point where it is almost a cliché: “Don't put all of your eggs in one basket.” One way to decrease volatility in your portfolio is to broadly diversify. Diversification should not just be that you own a number of different stocks and bonds, but that those holdings be spread among multiple baskets of asset classes. To be diversified across large and small companies, international equity and bonds of varying maturities can create a balance that can make for a smoother ride for your money. A study published in 1991 in the Financial Analyst Journal indicated that market timing and good stock selection only account for about 9% of successful investment results, but that asset allocation accounts for 91% of the outcome. It is sort of like a well thought out flower garden. You have flowers that bloom at varying times of the year. When one flower may be out of season, others are in full bloom. When those flowers begin to wilt, the out of season flowers come into their season and begin to bloom. When one part of your diversified portfolio is “out of season” and not doing well, another part of the portfolio that is “in season” can be a counterweight and smooth out volatility.
Know the Difference Between Investing and Gambling
I believe in getting rich … slowly. A long term approach that is broadly diversified and consistent with your age, your goals, and your tolerance, for risk will be much more capable of providing you with the ability to sleep well at night when the loud voices on the financial news programs are forever speculating on the “next big thing” that will make you rich quickly. There can be a fine line between investing and gambling, and we need to be very careful that we do not allow the professional gamblers of the financial world to tempt us to step over that line.
Modern Portfolio Theory is a Nobel Prize winning approach to money management. First introduced by academic researcher Harry Markowitz in 1952 and popularized through bestselling books such as “A Random Walk Down Wall Street” by Burton Malkiel and “The Intelligent Asset Allocator” by William Bernstein, it is an approach to managing portfolios that seeks to base decisions on financial science instead of speculation, and hype. One of the central tenets of Modern Portfolio Theory is that markets are fundamentally efficient. In other words, the reason that a share of XYZ stock is trading at $40 is because, with millions of investors bidding on that stock in a free market environment, the market has established that price as what it is worth. So much of investing today is based on trying to find the bargain, to discover that undervalued stock that is going to be the next Google. The reality is that studies have shown that most actively managed mutual funds that are attempting to “beat the market” actually underperform the market in a given year. For every Warren Buffet is able to consistently find the bargains, there are many others in attempting to beat the market end up being beaten up by the market. As Modern Portfolio Theory proponent Rex Sinquefield put it, “North Koreans, Cubans, and active money managers are the only people in the world who want to ignore free market pricing.”
Sometimes a fresh set of eyes and an independent voice can help you to determine if you are on the right track or if changes are called for. Perhaps it is time that you asked for a second opinion when it comes to your financial health. Call our office at (304) 346-7782 or (800) 361-1792 and arrange a time to talk with Shawn Moran, either in person or on the phone. You’ll be glad that you did.