By Mary A. Malgoire, MBA, CFP
This article originally appeared in the January-February, 2003 issue of ChesapeakeHome. Reprinted with permission from the publisher. Statistical information contained in this article was valid at time of printing.
In April of 2002 I met with a couple that sold a million dollars worth of solid, income-producing real estate in 1999 and invested it all in technology stocks. They asked "what should we do now"? But they were also looking for the answer they wanted to hear—that their tech stocks would go back up. I can only imagine how devastated they feel now, with the NASDAQ down another 18 percent since we met.
Times are tough in the stock market today. But dealing with these tough times is not about surviving and getting back to "normal". It’s about embracing investment wisdoms and changing behavior and psychology for good. Here are some observations about being a successful investor in all types of investment weather.
Observation #1: Don’t make the media your investment advisor.
Remember that the magazine at the grocery checkout stand with the screaming headline: "The Ten Best Mutual Funds NOW!" is yesterday’s news. The media writes about what sells. So, during the technology bubble stories were about rags to riches. Today, the stories are about retirees losing everything and going back to work. If anything, think of the media as a contrarian indicator. Be cautious when they are enthusiastic and vice versa. Which brings me to my next point:
Observation #2: No one knows what’s going to happen next! Even the "experts" don’t know.
The couple above with the boatload of technology stocks expected "the expert" (me) to know. Expecting psychic skills from your financial advisor can mean that you ignore and worse, abandon, the truly important service an advisor can deliver—a plan that is realistic, a plan that considers both return AND RISK, historical perspective on investing, and being your ally and advocate in the complex investment landscape. This brings up a very important point.
Observation #3: Investing is about proper portfolio construction.
It’s not about figuring out the next winner. Many investors fell prey to #1 and #2 above and decided that piling into technology stocks was the only sensible thing to do. The truth is that the prudent thing to do is to have an investment plan and stick to it. My experience is that there are no short cuts.
So, what about proper portfolio construction? Read on.
Observation #4: Diversification is your friend.
Diversification means that you do not own a lot of the same thing. For example, a small cap and a large cap equity fund may seem to provide diversification but they’re both U.S. equities. It means that you own investments that respond differently to economic events. An easily understood analogy—pretend the world consists only of rain or sunshine (the economic events). When it’s raining umbrella companies do well, and vice versa for suntan lotion companies. By owning only suntan lotion companies, your portfolio does badly when it’s raining. By owning only umbrella companies, you don’t do well in sunny weather. Solution? Own a little of both companies. This is what diversification is all about. The point is that while something is going down in your portfolio, something else is usually going up.
Does this mean everything cancels out and you earn nothing? No, because not everything you invest in returns the exact opposite of something else. For example, while U.S. equities fell 15.1 percent during the past year, real estate investment trust stocks (REITs) appreciated 6.5 percent, not a perfect offset. Also, every portfolio should include a healthy amount in equities for growth when times are good. The key to long-run success is to be climbing back from a pothole, instead of a sinkhole, when markets decline. This is what diversification can do for you.
Observation #5: Stay invested.
The measure of a good investment plan is that you can stick with it in bad times. Many investors are selling out now because "the plan" was too aggressive—either emotionally (can’t sleep) or financially (need the money). Investors are now re-aligning their portfolios hoping to reduce risk just as they added more equities (hoping to increase growth) during the bubble. So here are two impulse transactions that should have been avoided altogether: buying at the top, selling at the bottom. This kind of activity results in poor returns. A recent (June, 2002) Dalbar study shows that between 1984 and 2000, the average equity fund investor realized annualized returns of 5.3 percent versus 16.3 percent for the S&P500. This stunning difference is because most investors move in and out of their equity funds, making bad decisions about when to buy and sell. Investors selling now could find that they are locking in risk, not reducing it, because, by selling, they will be left behind when the markets grow again. Their financial security will be permanently impaired.
If you, alone, cannot take full credit for your misery, remember this too:
Observation #6: Brokers are not financial advisors (despite their expensive ads designed to convince you of this).
Trace the money. Their compensation structure (commissions from product sales) is fraught with conflicts of interest. What has to happen for your broker to get paid? You must buy, sell, or you must own a fund with high enough fees to pay both the broker AND the fund manager. Don’t get me wrong, brokers are good people; but the brokerage system is not designed with you, the investor, in mind.
Observation #7: Understand your financial life thoroughly.
Most people don’t know how much they spent last year, or how much is in their checking account, or what their tax bracket is, or why they own a deferred annuity ("my broker recommended it!"). Financial advisors are able to help their clients, in part, because they know the facts, cold. Any plan starts with where you are now. This may mean you need to...
Observation #8: Overcome your anxiety around money.
If just peeking at your tax return sends you into a fetal position, let me recommend Olivia Mellan, a nationally-recognized "money therapist", located in DC. She has several books that can help, including her latest, Money Shy to Money Sure. I also like The Seven Stages of Money Maturity, by George Kinder. Get some help. Don’t be left behind or left out of financial security and success.
Yes, things can go seriously wrong. Don’t punish yourself for going overboard during the "bubble". Practically everyone did. Going forward, take with you the knowledge of how easy it is to lose perspective. But let go of the guilt and remorse and move on. Pick up the pieces from wherever you’ve landed. Getting burned doesn’t mean you should stay out of the kitchen. THE ONLY road to financial success and security is through saving and investing!
