Investor Mistake #1 – No strategy
June 16th, 2009
From 1988 thru December 2007, investors underperformed the stock and bond markets by -7% and -6% respectively. It is an empirical fact that individual investors sabotage their own portfolios because they have no strategy. If you think you are an exception, you should have what professionals call an Investment Policy Statement that describes your strategy by answering questions like the the following:
What is the target return for your investment portfolio? 4-6%? 7-9%? 10-12%?
How much risk are you willing to take in order to get that return? Are you willing to lose 40% of your portfolio one out of every five years in order to have a 65% chance of averaging 12% over 20 years? How much risk is acceptable as defined by the “volatility” or “variablity” in your annual returns?
What is the time horizon for your portfolio? When do estimated withdrawals from your portfolio exceed the contributions and earnings? Ten years from now? Twenty years? Fifty years?
How many asset classes do you use? Three? Five? Seven? What is your target allocation for each asset class? What are the band limits? When do you rebalance?
Have you chosen an active or passive management philosophy for security selection?
If you have chosen active management for the equity (stocks) asset class, what strategy have you selected? Do you buy growing companies or beaten down value companies? Do you use a buy and hold, momentum or market timing strategy?
Achieving investment goals requires a plan and a strategy. One of the most frequent mistakes investors make is they have no written plan or strategy to address some of these most important questions.
Ten Mistakes Investors Make
June 8th, 2009
There is a difference between investor and investment performance. In 2008 the US stock market, as measured by the S&P 500, lost 37.7%. But investors did even worse by losing 41.6%. The US bond market, as measured by the Lehman Aggregate Bond Index gained 5.2%, but bond investors actually lost 11.7%. In other words, the stock market as an investment outperformed investors by 3.9% and the bond market beat investors by 16.09%.
This is not just a one year phenomenon. Every year the Dalbar company measures how investors performed compared to the capital markets themselves. For the 20-year period from 1988-2007, the US stock market, as measured by the S&P 500 returned 11.81%, but equity investors only earned 4.48%. For the same period, the US bond market, as measured by the Lehman Aggregate Bond Index, gained 7.56%, but fixed income investors earned only 1.55%. In other words, over the past 20 years the stock market outperfomed investors by 7.33% and the bond market beat investors by 6.01%. If we’re not shocked, we should be.
What are investors doing wrong? How do they unintentionally sabotage themselves?
These are ten broad categories of mistakes that we have seen investors make:
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They have no strategy
- Their strategy is to beat the market (Market Failure Theory)
- They don’t hold themselves accountable (No Benchmarks)
- They listen to the media more than the math (The Loser’s Game)
- They don’t count the impact of costs (SEC Cost Calculator)
- They let emotions overrule numbers (Behavioral Economics)
- They don’t understand or set a portfolio time horizon
- They don’t define long term (Speculators vs Investors)
- They don’t understand all the risks
- They measure risk tolerance instead of risk capacity
Most investors believe they are the exception, but it’s pretty easy to prove they are not. People’s Financial Advisor offers a Financial Checkup that will estimate the cost in your personal portfolio from just one common mistake. In future postings we will explore each of these mistakes in greater detail.
Rebuilding Trust in Financial Markets and Advisors
June 7th, 2009
While on a New York media tour for our new company, Peoples Financial Advisor, I heard one question more frequently than any other: “What are you doing to rebuild people’s trust?” At the time, financial reporters were losing their jobs because trust was in very short supply.
Trust is the foundation of all business, including the advertising dollars that support media. Without human trust, a modern economy cannot exist and capital markets cannot function. Money itself is an invention of human trust. Whether it’s in the form of clay tablets, coins or plastic credit cards, money is nothing more than a “promise to pay” and belief in the promise. So I don’t think the problem is public trust. The economy is still functioning and as far as I can tell everyone is still using money. We are by nature an optimistic people. We want to trust our government, financial institutions and advisors.
But we’ve just learned that we’re never more vulnerable than when we trust. Misplaced trust created the economic bubble. The loss of almost twenty trillion dollars or 40% of personal wealth is a measure of our financial vulnerability when we, the public, misplace our trust. I personally think the new found skepticism is healthy. I believe the personal losses in our real estate and financial portfolios were the “price” of a valuable lesson for all of us.
So what am I doing to rebuild trust? From 16 years of counselling and building non-profit organizations I learned that the way to win trust from others is to focus on being trustworthy. I want Wall Street to spend fifty billion dollars a year on becoming trustworthy instead of advertising to win trust. I want the media to acknowledge it has the same conflict as the cigarette industry. I want the financial media to post warnings that it cannot survive if it doesn’t arouse emotions and sell copy and “this advice may be hazardous to your financial health.” I want regulatory reform to require an authentic fiduciary standard of care for anyone offering financial or investment advice to the public.
As for individual investors, what were our expectations before the collapse? Were they reasonable? Did I expect for-profit financial institutions and advisors who sell products to put my interests ahead of profits and compensation? Did I believe that I or my advisor could beat the market by looking into the future to pick winners and avoid losses? What lesson will we learn from our losses? Will we blame advisors, the media, politicians, financial institutions or capital markets? Will we learn not to trust anyone or anything? Will we return to the days of putting our money in the mattress and not asking anyone for advice or help? If so, we may be setting ourselves up for more disappointment.
It’s true, we are never more vulnerable than when we trust, especially when it comes to money and love. But it’s also true that if we never trust we will never experience financial freedom or rewarding relationships. Perhaps some of us just need to rebuild our trust in ourselves. Everyone has the ability to learn. Everyone has the ability to make better financial decisions. Trust me on this.
Someone once said broken trust is like a glass vase. You can glue it back together, but it will never be the same. I agree to a point. If people learn from their losses, their trust will be reinforced with wisdom.
Don’t Turn Down Free Money!
May 19th, 2009
One key to building wealth is “Don’t turn down free money!” When you maximize contributions to your qualified retirement plans you accept free money from three sources:
1) The taxes you normally owe the government,
2) The interest earned on the government’s tax dollars which are now inside your retirement plan and
3) The interest earned on the interest.
By maximizing your pre-tax contributions you accept the government’s “free” money, build wealth faster and are able to retire sooner.
Let’s assume you are married with a household income of $48,000/year, and you are my neighbor in Colorado. Let’s also assume you are contributing 6.25% of your salary or $3,000 annually to your 401(k) plan. Should you increase your contribution by $1,800/year to get to the lifelong minimum savings rate of 10%?
If you are in the 15% federal tax bracket, you are paying an unnecessary $350 in federal and state taxes, by not contributing the additional $1,800. In other words, Uncle Sam and the State of Colorado will reduce your taxes by $350 if you will put an additional $1,800 into your retirement plan. That’s an instant 19.4% return on your savings.
In reality you are only putting $1,450 of your own money into your retirement plan because the additional $350 is the taxes you would have to pay Uncle Sam and the state if you did not defer your income. Sometimes, I call this $350 in deferred taxes the “government match”. It’s as if our government is paying you $350 to motivate you to save $1,450 of your own money. Isn’t this a great country?
In the table below we have calculated the value of this “free money” ($350/year tax savings) invested in a conservative portfolio of stocks and bonds* over 1-, 10- and 20- year time periods. The table assumes you remain in the same tax bracket every year.
| Tax savings each year |
$350 |
| Tax savings + earnings after 1st year (*) |
$380 |
| Added wealth after 10 years (*) |
$5,430 |
| Added wealth after 20 years (*) |
$16,830 |
(*) Annual return 8%, average fund operating expenses 0.3%.
There’s an additional bonus. Money in qualified retirement plans is protected from creditors by federal law (ERISA). Even though OJ Simpson was convicted of murder in civil court, the judge could not use OJ’s NFL pension money to pay the monetary damages he awarded to the victims’ families. Is it any wonder that many experts call Qualified Retirement Plans the “World’s Best Tax Shelter”? Maximizing contributions to your qualified retirement plans is the fastest way to build wealth that can’t be taken from you by creditors.
Check your own “free money” numbers at: http://www.peoplesfinancialadvisor.com/financial_checkup.php
