Note from MOAA: Get an updated version of this piece from July 2020 at this link.
I’m no know-it-all; far from it. I’m a sponge learning something new every day. It’s just that I’ve met plenty of people who didn’t follow the tips below and they live with regret. I base these points on my past as an investment adviser and counselor. That past allowed me to chat with many well-seasoned advisers, stock and mutual fund analysts, mutual fund and private money managers, and the research staff of some large well-known financial firms. I worked with many clients of varying levels of wealth (few thousand to multi-millions) and talk to hundreds of people a year in my current position. Talking to people who have made the following mistakes is uncomfortable but it’s more uncomfortable overhearing conversations among people ready to dive into this list of “don’t dos.” Many are or will become repeat offenders.
An ounce of prevention is worth a pound of cure…
1) Buy into what’s hot. The history is clear. An investment gets press. Greed overcomes. Everyone is in the game. “I’ve got to get a piece of the action.” “I’m being left out.” POP! You’re left holding the bag after buying high and the investment bombs. “I’m a victim!” In the last 12 years alone, it’s been the dot.com bubble, the housing bubble, the mortgage credit bubble, the 2008 Google downfall and now the Facebook public stock offering.
You can go back in time hundreds of years and the same things existed under different names. The fact remains that when an investment is in the news and the hucksters are out in force pumping up an investment opportunity, the end is near. It’s the last chance for shady salesmen to draw in the easy prey before they cash out and the prey gets blown up.
The latest, gold. A team of investment analysts once told me after their extensive historical research that gold does not do over the long haul what is commonly advertised—consistent returns and inflation protection. The only people who make money in gold are the speculators; those who buy low and sell at a profit before it reaches its apex—oh, and the people who sell gold when the masses have gold fever.
2) Work with a one-trick pony. By “one-trick-pony” I mean a financial firm with a limited product line and knowledge limited to that minimal product line. You have complex financial needs for your money and the management of your money; safety, protection, stability, consistent returns, growth, tax issues, estate issues. You need someone with vision, insight, experience, and knowledge of the numerous available savings/investment vehicles and how to use them. If you wanted to go out to eat where you have a variety of choices and a chef to expertly prepare the selections, you wouldn’t go to a hot dog stand. Yet this happens all the time in the financial world.
Companies and advisers with few options and no knowledge beyond their limited choices abound when you shop for help. Financial operations that specialize in a few products will make one of their products work for every customer that walks in the door. If every situation you propose is answered with a single or two products, you may be in the wrong place. What’s the saying? When all you have is a hammer, every problem looks like a nail.
Your options include selecting multiple one-trick ponies, each with their own bag of tricks and you act as the ring master over all their activities. Or you can find a knowledgeable, experienced, comprehensive adviser who’s able to handle most the chores. If you have a one-trick pony handling all your diverse needs, you are probably being forced into limited vehicles with questionable appropriateness and paying huge fees.
3) Get too conservative. This is meant for those of you a ways from retirement. Given the economy and the stock/bonds markets over the last 12 years, who could be blamed for getting conservative? However, you need stocks to build the wealth required for a comfortable retirement. There’s a lot of back-story to that last statement that can be found in this MOAA Financial Frontlines blog (http://moaablogs.org/financial/) by searching key words “how to investments.” Just don’t let the media with their doom and gloom stories and the fluctuating markets divert your attention away from you building wealth.
Learn how to manage your portfolio and the market environment. If you don’t, you’ll find out how being too conservative can be a very riskiest game plan. A lower standard of living, working for an extended period, or running out of money in retirement are all risks assumed when investments are managed too conservatively. I’ve met people close to retirement who managed too conservatively; some did okay, most didn’t. You don’t want to be in the latter group when you are closing in on retirement.
4) Get too aggressive. For you folks closing in on retirement, your primary mission is to protect value (secondary mission: some growth). You don’t want to be one of those folks who have a portfolio blow-up just prior to retirement. The trick is being balanced. Even in retirement you’ll need growth to ensure your money doesn’t run out. However, primarily, you’ll need protection to ensure your investments are available when you need them.
Here’s an idea if you are moving into retirement or in retirement. Think in terms of three separate time periods, stretching out in front of you, each having a separate investment strategy. The period furthest in the future grows the assets that will waterfall down keeping the middle and short-term periods full of assets.
The first, the short-term period is the 3 years directly in front of you. For years 1 through 3, the strategy is stable, protected money to live on over the next 3 years. The value of this account is locked in and has some interest rate return. Now you don’t have to worry about market volatility or the economy in the short term.
The second, middle-term period is money that will be available in years 4 through 6. The medium-term bucket requires a conservative, consistent return that keeps pace with taxes and inflation as best as possible. It can have minimally fluctuating values in order to achieve its objective. Individual bonds with laddered maturities may be an option. Other options can be conservative mutual funds with outstanding track records during rocky market periods.
The last and long-term period has the majority share of your assets; a growth portfolio based on a vision of 7+ years. The long-term bucket will need a minimum of approximately 40% stocks to maintain enough growth to offset taxes and inflation over decades. A possible option could be well-managed balanced funds.
Picture the waterfall. Profits from the long-term bucket will fill the medium-term bucket and medium-term bucket will fill the short-term bucket over the years. If you aren’t adding to the buckets regularly with new money, your portfolio allocations in the mid- and long-term buckets are critical. If you are still contributing to your accounts, contribute to the long-term bucket. Review your status regularly.
5) Get emotionally attached to your money/investments. This is a tough one because naturally we are emotionally involved with our money. More money is good; less is bad. We are fearful if our balance goes down or we might run out. We are greedy when the balance goes up or we see other more glitzy investment opportunities.
Emotion is the worse reason for making a financial decision. Let’s review some issues associated with emotional financial decisions: a moment of joy after an impulse buy followed by buyer’s remorse, shock over the amount of debt, and anguish at the thought of the payments. Or perhaps it’s the sure-fire investment tip that blows-up.
Money management requires a cold-blooded, unemotional mental state. You will be required to do things you don’t want to do and resist things you want to do. It’s about knowledge, discipline, willpower, and making the tough choices. There is no room for emotional attachment. If you are feeling something, stop it and think facts and analysis. Think in terms of requirements and not desires.
It’s too hard for many and is why so many people seek a third party to help maintain unemotional discipline.
6) Invest in individual stocks. Let me qualify this statement. Don’t invest in individual stocks before you’ve laid a solid financial foundation in more suitable investments for your retirement and other long-term investment needs. Individual stocks are not the vehicles to ensure a secure future for the uninitiated or the part-time dabbler.
Investing in individual stocks requires in-depth knowledge in what you’re investing in and why. Stock investing is not about knowing what’s hot or what’s getting news coverage or what friends and family are saying. Stock investing is time consuming and knowledge intensive and you’ll still be the last to know when something is going to go wrong. A perfectly fine stock today could blow up over a simple news release tomorrow and that will bring down your best plans.
Individual stocks are too volatile and unpredictable for average investors. Even the professionals pick a bushel of stocks hoping a quarter of them carry the water for the ones that don’t pan out. How much money and how many stocks would you have to own to plan for 25% of your selections carrying the 75% that don’t work out? Don’t gamble away your future. Mutual funds provide professional management, larger portfolios of diversified stocks, an affordable way for average investors to invest, and don’t require your constant attention.
7) Invest in a bond mutual fund expecting individual bond performance. When you buy an individual bond, you buy it for a set price, it pays a set interest rate and it matures to pay you back a set amount. Bond mutual funds do none of that. First off, a fund is a portfolio of many bonds; not one bond or a specific bond issue. You buy the fund at the market amount, it pays interest based on its ever changing bond portfolio, and you sell at its market amount. You could lose account value or actual money on the deal.
It’s best to view bond funds as a piece of your total portfolio allocation or diversification. Generally, they provide some growth potential and income payments better than fixed-rate savings and but less than stocks. Generally, they provide more consistent value protection than stocks but less than fixed-rate savings. Typically a bond fund is used to provide a stabilizing effect in a stock portfolio. They are also used to provide income payments for people more interested in the income than a fluctuating account value.
Be careful out there.