A Gigantic Casino?

 A Winning Hand

Some people think of the stock market as a gigantic casino and worry about getting ripped off. Part of the reason is that they act as if it is a casino. In the short term, the stock market goes up and down a lot, often for no apparent reason. Over the long term, the market moves with the economy and is much more stable, particularly if your portfolio is widely diversified. If you hold one stock or a handful of stocks or trade a lot, you are taking big bets. If you spread the risk among thousands of companies around the world, the risk of an unfavorable outcome drops dramatically. One of the biggest mistakes people make is trading in and out of the market based on today’s headlines. If you trade aggressively or if you hold only a few stocks, you may win big. A lottery ticket will also pay off for someone. But do you really want to trust your future to a game of chance with slim odds? Why not use a thoughtfully designed portfolio instead? Skip the casino with your investments and the chances of a winning hand will be much better.

Just Sit There

A Zebra in Lion Country

Little captures the American spirit better than Nike’s “Just Do It” slogan. Americans like to be positive and to take action. They are not good at being patient.  Many investors aren’t patient when the news is horrible and there seems to be no hope. The debate over the U.S. budget deficit has shaken confidence around the world.  But we know from experience that the economy goes up and down. We have good times for years with plentiful jobs and markets surge. Then everything falls apart and there is no light at the end of the tunnel.  Over the last century recessions have generally lasted less than a year and often are followed by a steep market recovery. Trying to time that surge is a losing battle. In the book “A Zebra in Lion Country,” Ralph Wanger describes trading frenetically during the stock market crash of 1987.  At the end of the week he stepped back and found that he’d accomplished nothing. Pushing the panic button may bring relief but it’s no substitute for careful thought and a well designed portfolio.  “Just Sit There” sounds terrible but it’s saved many investors and eventually the turbulence will pass. 

Mired in Despair

A Glimmer of Hope

When I talk with prospective clients about their financial future, I find that their feelings range from apprehensive to despair. Few seem at all hopeful or optimistic. This is natural amidst the deadlock and acrimony in Washington and in the aftermath of a devastating recession and fitful recovery. And yet we know from history that we are likely to see better times in the future. It has been a modern conceit that we could override human nature and suppress the business cycle. What we have shown is that with great technology and modern communications, we can accelerate the business cycle and perhaps make the downturns worse, not banish them. Still, just as we’ve experienced a historic bust, we’re likely to have a historic boom again at some point. It pays to be realistic but not get mired in despair. Those who are too gloomy may make bad mistakes and get disappointed yet again – when once again good times roll. And failure to plan for prosperity can be almost as big a mistake as assuming that hard times will never come. Successful investing requires balancing prudent risks and that means balancing emotions too.

Illusion of Control

Bad Behavior

“We have met the enemy and he is us.” That’s the famous quote from Walt Kelly, cartoonist who drew the Pogo series. It applies especially to investors. A study by the financial consulting firm Dalbar showed that for the 20 years ending December, 2010, investors achieved less than half of the return for the mutual funds they participated in: 3.83 percent a year for investors versus 9.14 percent for the funds. Why is this? In large part because investors let emotions dictate their actions rather than put thought into what they are doing. They let fear and greed dictate buys and sells. Recently we sponsored a talk on a behavioral approach to investing. The speaker, Jay Totten of Dimensional Funds, used recent research to show the inherent problems investors have and how to counteract them. The problems he cited included overconfidence, illusion of control and aversion to loss. He suggested that one way to minimize these problems is to stick to a plan. He recommends focusing on good decisions, not outcomes, and controlling what an investor can control such as diversification. That makes it easier to accept what happens, which is partly a matter of chance. 

A Haphazard Mess

 Neatness Doesn't Count

Years ago I learned that neatness doesn’t count in managing an investment portfolio. But recently I’ve seen lots of portfolios that are a haphazard mess. Most people make investments one at a time and don’t consider the whole. Sometimes I feel like an archaeologist studying layers of a site inhabited by many different peoples. I see shifting themes and investments accumulated while that theme was in force. The problem with investing this way is that major drivers of investment performance – such as asset allocation, diversification, geography and style – operate on a unified portfolio. Many people rely too heavily on a single stock. In a bull market such as the stealth one we’ve had for two years, it’s harder to see the flaws in your portfolio. An overly cautious asset allocation means you are making less money, not losing. But the seeds of destruction are planted in good times and reaped when the investment skies darken. Too many people spend too much of their time worrying about money and not mitigating the risks or planning for prosperity. If you know what to look for, it’s not hard. If you don’t, these flaws are invisible until trouble suddenly appears.

A Workable Plan

Hope and Reality

Frequently I meet with people whose finances have been devastated by the recent recession and stock market crash or who are elderly and nurturing a tiny nest egg. Sometimes I can’t do much. The seeds of this distress were usually planted years if not decades ago. People often ignore basic tenets of financial affairs like proper diversification. They often invest haphazardly or simply don’t pay attention or lack financial knowledge. But with most people steps are available that can put them on an improving path. Many people actually have enough assets and just don’t know it. They may only need to put their records together and come to a new understanding of their position. Often, though, I wish that I could have met with them in their 20s, 30s or 40s. At that point, it’s much easier to develop a workable plan and help people to understand how to achieve their goals. No matter what your predicament or situation, it doesn’t pay to sink into despair. The view of an objective professional who is trained in finance can outline the tradeoffs and opportunities and bring hope and reality back into the equation.