A few years ago I came across a humor book called
Momilies, a collection of funny advice and admonitions from
mothers to their children.
The classic was, "If you fall out of that tree and break your
leg, don't come running to me."
I was reminded of the book while thinking that some of the best advice about investing (and life as well) can be derived from the proverbs learned at your mother's knee. This opinion relies upon the sometimes radical notion that there is a direct correlation between successful investing and common sense.
You don't get something for nothing. One of the most valuable pieces of advice that we must perennially relearn, this warning is as difficult to follow in adulthood as it was when we were kids. Ignorance of this basic truth is what makes us believe that we can invest in something with an impressive rate of return without risking a good portion our capital.
Look both ways before crossing the street (also see act in haste, repent at leisure) is the basis for "investigate before you invest." Over the years I could have saved a lot of money by checking out those hot tips and last-minute opportunities that fortune (both good and bad) dropped into my lap.
Don't be selfish, share is good investment advice, particularly when your stock price has appreciated far in excess of what you could reasonably expect. Maybe it's time to sell the stock to someone else and allow them to share in future profit (and risks).
Education is important (better known as Do your homework!). In investing, as in life, what you don't know is far more likely to hurt you than what you do know. You can't be successful over the long run just by buying stocks recommended in financial magazines and on television shows. You have to learn the basics about securities and securities markets.
How many hours a week do you spend really studying investments and markets (and not just looking up prices or reading Alan Abelson)? At what price is your stock a buy and at what price is it a sell? And just how did you calculate those prices?
There are many others: If it seems too good to be true ... A stitch in time ... (i.e., cut your losses), Save for a rainy day ..., Life is not fair ... (e.g., bad things can happen to good stocks), not to mention the one which all professionals use to describe the virtues of diversification: Don't put all your eggs in one basket.
And anyone who has had a poor investment experience dealing with someone they didn't check out beforehand can appreciate: Don't talk to strangers.
But my favorite expression should be the motto of all contrarian investors - particularly now, when everyone is certain that this stock market is different and that trees can grow to the sky.
This is the cliché which every parent has, at one time or another, sworn never to use but, when pushed to the wall by exasperation and emotion, will use nevertheless: If all of your friends wanted to jump off the Golden Gate Bridge, would you want to do it too?
Unfortunately, as far as investing goes, our response today is likely to be the same one we defiantly threw back at our parents so many years ago.
[Originally published in the San Mateo Times on January 17, 1994 as COMMON SENSE BEST ADVICE WHEN IT COMES TO INVESTING]
Allan Roth in his regular column for CBS MoneyWatch recently wrote how some advisors rationalize their behavior, convincing themselves that they are meeting their fiduciary duty to their clients when, in fact, they are only benefiting themselves. Allan is a very talented advisor, not to mention a friend, and I normally agree with virtually everything he writes. This time, though, I totally disagreed with his assertion that he “…could only exercise true fiduciary duty of putting my client's interests ahead of mine by lowering my hourly fee to zero.” I feel strongly about this because I know Allan to be scrupulous to a fault and someone who is far more likely to undercharge his clients for his very valuable services.
A fiduciary obligation does not mean you cannot be fairly compensated for your work nor is a fiduciary required to take a Vow of Poverty. “Fiduciary,” as defined by the CFP Board, means “one who acts in utmost good faith, in a manner he or she reasonably believes to be in the best interest of the client.” Being a fiduciary is all about acting ethically and the acid test is how you resolve the inevitable conflicts of interest.
Compensation is the most common and, arguably, the most serious conflict of interest but getting paid for your work does not disqualify you as a “true fiduciary.” Private fiduciaries serving as conservators are not expected to work for free. Certainly their fees are subject to court scrutiny and there is always the chance of abuse, but no one would begrudge the conservator fair compensation for his or her labor.
The same holds true for the investment fiduciary. It is not the absence of compensation that proves that the advisor is meeting his fiduciary duty but whether the advisor is working in the best interests of the client. Clients should receive financial benefits that are significantly greater than the fee which must be reasonable, proportional to the advisor’s labor and expertise, and completely transparent to the client. In addition, the advisor must take pains not to waste client money by using the most cost-effective strategy and investment products even if an unnecessary cost does not directly benefit the advisor.
Allan knows that exercising a fiduciary duty is hardly a lucrative business model to begin with. If that were not the case the financial services industry wouldn’t be fighting tooth and nail to avoid a strict universal fiduciary standard. So while I appreciate Allan’s sentiment and altruism, I think his clients would agree with me that he can be both fairly compensated and a true fiduciary.
There is never a good time to invest in gold because gold is not an investment.
Gold is a commodity not a true investment because it cannot produce a return on investment in the traditional sense. Bonds pay interest and many stocks pay dividends.
Gold not only doesn’t pay interest or dividends, it costs something to properly store, authenticate and transport gold, so owning bullion creates a negative cash flow – the opposite of a return on investment.
The real value of common stock can increase when a company reinvests profits in the business. As Google’s value as a company has grown so has the intrinsic (book) value of each share of Google. But an ounce of gold will never be more than an ounce of gold.
So why buy gold if not as an investment? Gold is normally purchased as a “hedge” against some risk. Generally these are currency-related risks: inflation or possible currency devaluation. But people really aren’t so much buying gold as they are getting out of depreciating dollars.
At the extreme are some people who buy gold as a store of value against some social catastrophe – the total collapse of civilization. These are the “Doomsday Preppers” of reality TV who believe that after this collapse, paper dollars will be worthless and gold will make them wealthy. Under that scenario I think lead would be far more valuable than gold – so long as the lead is in bullet form and stored in a gun.
I think a lot of new buyers are attracted to the decade-long rise in gold prices from $300 to $1,900 and are betting that prices will continue to rise. They may give inflation as the reason, but it is my suspicion that these justifications are largely an afterthought and the real motivating factor is human nature – the lure of getting rich quick.
What really drives gold prices? Like all commodities, gold prices are determined in the short-run by supply and demand and in the long run by inflation. Since gold has limited industrial uses (jewelry and electronics) and new supplies cannot easily be delivered, it is primarily investor expectations that drive the price. In other words, gold is worth what people think it is worth.
So there may be a good time to buy gold as a hedge and there could be a good time to make a bet on rising gold prices. But invest? Never.
PS: In 1980 Gold prices peaked at $850 an ounce and inflation was peaking well above 10%. Nearly everyone believed that at least 15% of your portfolio should be in gold to hedge against future inflation. Over the next two decades gold prices slipped to $300 an ounce. If you bought gold in 1980 and it had kept pace with inflation, an ounce of gold today would be worth more than $2,500. 1980 – now THAT was a bad time to invest in gold.
This White House is famous for the phrase: “you never want a serious crisis go to waste” so I guess when you run out of real crises, inventing one would seem a good substitute.
It now seems clear The Sequester will take place on Friday (barring some “kick-the-can-down-the-road” postponement) triggering automatic across-the-board spending cuts. This is a manufactured crisis – a self-inflicted wound. It never had to happen and, in any case, there has been more than enough time to avoid it. Nevertheless it is here. If you believe President Obama’s predictions of the consequences of Sequestration: kids will be sent home from school, first responders will be furloughed, the borders will be wide open, air travel will slow to a crawl if not come to a complete stop and the military won’t be able to defend the country.
In Washington this is known as “The Washington Monument” strategy. If the National Parks Service faces a budget cut they first try to scare the public by howling that their only option to save money is to close down popular attractions like the Washington Monument. But as we are all painfully aware, every government organization has redundant, inefficient operations that can be scaled back or eliminated before you come close to cutting muscle and bone.
The Sequester is an unnecessary and unfortunate event and while it will cause damage it is not a catastrophe. The cuts only amount to $44 billion, 3% of the budget, over the course of the fiscal year. So let’s be clear: under sequestration government spending will not decrease, it will increase but at a lower rate. It’s considered a cut only because of the goofy way government scores a reduction in planned spending growth as a cut.
Yes, this will hurt the economy and it will disrupt government. More than any other part of government, the Defense Department will be hurt most since it must absorb a disproportionately high 50% of the cuts. But speaking as a retired military officer I have to say that the military has much bigger problems to deal with not the least of which is a leadership vacuum at the top. It is a shame that the military must always be held hostage to partisan politics but that’s the way it has always been and will continue to be.
Every cloud has a silver lining and the Sequester could turn out to produce more than a few positive outcomes. A little less government spending when we are borrowing 40% of every dollar spent is not a bad thing. And if, as is being proposed, Congress allows agencies to make their budget decisions based on real priorities instead of a blind across-the-board cut then we might see at least a marginally more efficient government.
But more than anything else if it finally gets public attention focused on the serious, long-term fiscal problems facing our country and how little our elected officials are doing about finding realistic solutions, then the Sequester could turn out to be a gift in disguise.
Don’t fear the Sequester – worry about the people who caused it.
Ask the average investor how his portfolio has performed and you may hear “Great, I was up 10%!” or “Terrible, I was down 10%.” But if the market as a whole was up 20%, that 10% gain comes up short. Conversely, a 10% loss in a market down by 20% looks pretty good.
While absolute returns are what really count you need comparative metrics to honestly judge a strategy’s effectiveness. Looking strictly at absolute performance could convince an investor to abandon a sound strategy or dedicate more money to a poor one. Better to add the following measures:
Compare apples to apples. Always measure performance against a comparable index. If you invest in large capitalization US stocks then the S&P 500 index is the appropriate benchmark. For smaller stocks, non-US stocks, bonds or anything else, use the benchmark that tracks that particular asset class. In a diversified portfolio each asset class must be compared against its own index to get a true measure of performance.
Adjust for risk. Higher returns indicate higher risks. When risk-taking pays off (as in 2012) it makes higher risk strategies look attractive while conservative strategies can seem unproductive and boring. Junk bonds should have higher returns than safe bonds during good years to compensate investors for the outsized losses they produce in down markets. Don’t confuse risk-taking with sound strategy. Case in point: the best-performing asset in 2012 was Greek bonds (+80%) followed by Greek stocks (+40%). Enough said.
The Acid Test. True performance is best measured against investment objectives. Did your results make achieving your goals more likely – or less? Were losses or gains greater than expected? Do you still have confidence in your plan?
Good navigators periodically fix the ship’s true position and make the necessary course adjustments. Investors must do the same.
[Published in MOAA Financial Frontlines, February 20, 2013]
One of the most popular techniques for choosing mutual funds actually doesn’t work well in practice. Shockingly, Wall Street and the financial media encourage its use.
An easy and intuitive way to choose a mutual fund is by comparing fund performance over time. It seems logical to conclude that funds with the best historical performance will continue to outperform in the future. Unfortunately that’s not what happens as study after study has shown.
Markets change and the strategy that makes you the most money in one market can quickly lose you the most money when the market shifts. Some of the top funds in 1999 ended up being the worst funds for the next few years. By the time investors realized what happened, the damage was already done.
Using historical data to choose a fund virtually guarantees that you will be late to the party – investing after profits have already been earned. And when, inevitably, last year’s star fund underperforms, this same rear-view mirror strategy encourages selling it (after the money has been lost) and reinvesting in some new “hot” fund. Wall Street calls this “chasing performance” but rarely discourages it since performance is what Wall Street implicitly sells.
Nor will Wall Street tell you that a low expense ratio is a much better determinant of future mutual fund performance. All funds charge management fees and over time the better performing funds also have the lowest expense ratios. Despite that fact few investors know what they pay and some don’t think they pay anything at all.
Once investors have narrowed their choices to those funds that match their investment objectives and risk tolerance, they should choose the fund with the lowest expense ratio. While that fund may never show up on any list of best (or worst) funds, it is much more likely to produce superior long-term returns.
[Published in MOAA Financial Frontlines, January 3, 2013]
Investors expect the Government to protect them against risks but what if that same government actually exposes them to danger? Fed Chairman Ben Bernanke wants savers to take more risk – and a lot of them are taking him up on that. Interest rates on “high-yield” bonds fell to record lows in mid-November. These higher-risk securities (better known as “junk bonds” because of the low creditworthiness of the borrowers) have become popular along with just about any other investment product that promises above-average yields. But do the buyers always appreciate the extra risk? I doubt it.
By driving short-term interest rates close to zero, Bernanke is pressuring traditional savers to take on greater investment risk – knowingly or unknowingly. Now the Chairman’s ultimate goal is not to punish savers but rather to stimulate the economy – although after 4 years of this, you have to question the effectiveness of his strategy. Nevertheless, the result is the same – the typical saver who relied on income from savings accounts and CDs has been forced to choose between punishingly low returns or higher risk investments.
The real crime here is that, by definition, traditional savers are very unsophisticated when it comes to judging the risks of investment products and can easily be led astray by unscrupulous or uncaring salesmen. This is particularly true when the need for income overcomes their natural skepticism. People begin to believe that maybe this time they can get higher return without greater risk even though, in their heart of hearts, they know better.
Savers can protect themselves by following a few simple rules:
- Remember that “there is no free lunch.” Higher returns always involve higher risks and just because you don’t see any risk doesn’t mean it isn’t there.
- Don’t take risks when you can’t afford to lose. If a bad outcome will seriously erode your standard of living you can’t take the risk regardless of the potential payoff. “Don’t gamble with the rent money even if you think it’s a sure thing.”
- If you can afford a loss, be sure that you are adequately compensated for taking on higher risk. If a high quality bond will pay you 4% how much more should you ask from a less-creditworthy borrower who might stop paying?
Misguided government policy causes collateral damage. Don’t let it happen to you.
[Published in MOAA Financial Frontlines, November 27, 2012]
Nothing is more important to investment success than an effective investment plan. A well-developed investment plan helps you make good decisions. But a well-developed plan is useless if it isn’t followed. Ignoring your plan is not only a waste of time, money and effort, it can easily lull you into a false sense of security.
A critical part of a good plan is monitoring and maintenance. How often you should perform that maintenance depends on a number of factors but a comprehensive review of the plan and the investments should be conducted at least annually. Even the best investment plan can lose its effectiveness as markets, investments and personal situations change. When I was in the Navy (before the days of GPS) we knew that as soon as we left port the wind and waves would immediately begin to push us off course. We periodically had to determine our true position to know precisely where we were and then make the proper course corrections to get us safely to our destination.
We understand that if we don’t maintain our car it is likely to break down – generally at an inconvenient time. We learn that regular oil changes and tune-ups are less disruptive, not to mention less expensive, than major repairs. If we are smart we take precautions rather than wait for a serious problem.
The same is true of annual checkups with our doctor and dentist. If the doctor gives us a clean bill of health, we don’t consider the visit to have been a waste of time. We value checkups because they can provide early warning of potential medical problems and allow us to remedy the situation before a more serious condition develops. The peace of mind that comes with knowing we are in good health is just a bonus.
If you don’t regularly review your investment plan and portfolio, you lose the opportunity to address developing problems which can result in large losses or forgone profits. When you conduct a comprehensive review you can answer important questions such as:
-
Am I on track to meet my financial goals?
-
How are my investments doing and how does that compare to the market as a whole?
-
Is my investment strategy working as expected?
-
How much am I paying in fees and expenses and can I reduce those costs?
-
What is happening in the economy and the securities markets? Are my investments properly positioned for likely risks and opportunities?
-
Do I have a clear overall picture with all accounts consolidated into a single portfolio?
-
Am I well diversified with the proper mix of stocks and bonds or do I need to rebalance?
-
Should I sell or buy anything?
-
Are there any upcoming events that I need to prepare for such as tax law changes?
Annual reviews help you spot potential problems and put you back on course. They also free you from the nagging suspicion that you should be doing something with your investments. That feeling not only makes you uncomfortable, it can tempt you to react viscerally to some event such as a big drop in the market or some unexpected economic shock. Annual reviews protect you by helping you stay true to your investment plan and in doing so pay an extra dividend: peace of mind.