Goals without a plan are really just hopes!
Understanding what a plan is, and what a plan is not, can be quite the process. I’ll tackle one aspect of this today by sharing a phrase I typically hear when the topic of investing comes up in social gatherings.
“With the amount of money I’ve saved, I figure that if I just make 12% a year every year for the next 11 years, then I should be fine.”
Unfortunately, a rate of return is not a plan, and “long-term” doesn’t always equal well-planned. Many investors aren’t self-aware when it comes to skill. When the market’s going up, they pat themselves on the back for being excellent captains of their investment ship, but in reality, it’s the good winds of the market that are carrying them where they want to go, not skill.
Investors seek rates of return, and their “plan” becomes achieving them–but a rate of return isn’t a plan. When the winds turn unfavorable, and suddenly their investments shift off their planned rate of return, they feel out of control and blame the market. They believe a market that isn’t rewarding their proven skill must be one not worth investing in, so they finally sell on the wake of a news story that pushes them over the edge from greed to fear.
Investors who fancy themselves stock pickers are especially prone to such an emotional reaction. The fact is, the most important decision investors can make is to be invested. We always debate about who the best investment managers are, but most of them beat sitting in cash more times than not.
Diversification itself is not a plan. Neither is the type of instrument used to invest, or the types of stocks bought, or how wide stop loss orders are set. These are components of a plan, just like the has in my car is a component of my plan to drive home. But gas alone does not equal an attained goal.
A good plan includes realistic expectations, and that’s often one of the most important things a good advisor provides. When a star basketball player hits seven jump shots in a row, it’s prudent to expect not only a miss pretty soon, but that at some point, a longer than normal series of misses will occur. The biggest problem with emotional investors who pull out after a loss (when the first “miss” occurs) is that the pain incurred makes it hard to get back in until things are much better–often after the biggest chance for making money (the jump shot streak) has passed.
Regardless of what strategy is used, investors should have set expectations for how their portfolios might respond under different market conditions. As always, diversification is important, but we all know that correlation increases when the market sinks, and there are many types of diversification. Unfortunately, there’s no benefit to diversifying between investment firms or between types of investments (e.g., mutual funds, ETFs, individual equities) It’s like having each family member drive a different vehicle to the same store–ultimately, you’re all going to the same place.
Investment advisory isn’t about calling stock market direction or being right all the time. It’s about preparing clients to know what to expect even if we’re all wrong, and still have the ability to meet a goal. The market moves in three directions: up, down, and sideways. Whatever happens, investors should know how their portfolio will likely react.
Investors obsessed with the financial news media are the most prone to emotional decisions and costly mistakes. Be wise: don’t buy into the idea that some fundamental indication is going to send the market into a tailspin or correction, or into an epic rally. The truth is, the talking heads will keep predicting what will cause a crash or rally until they’re lucky enough to see one of their predictions correlate with a market move; then they’ll say we knew it all along. The reality is that the success of an investment philosophy isn’t dependent on having an ability to call market corrections or their causes, but to set up a mix of strategies that take the money the market gives us when it’s generous and then slowly mine premiums from the markets using probability-based strategies.
Unfortunately, once a downturn happens, emotions and urgency are high, and it’s hard for investors to trust themselves, let alone seek wise counsel. They tend to sit on their hands and watch. The time to do something about a market correction is before it happens–when things feel good. If investors’ plans don’t include a deep understanding of what will happen to their portfolios if the market corrects, and if they aren’t comfortable with that, the time to trade in greed for a plan is now. Healthcare and financial advisory are the same in that preventive care may be more expensive in the short run, since it takes time and money, but acute care in the future is much more costly. A large rate of return is not a plan in and of itself, but the long-term returns that may be expected by one with a prudent investment plan may help an investor reach a goal.
Other articles filed under Fort Worth CFP Team Posts
Part 2: Volatile Markets – How the Financial Media Helped Build Demand for Dangerous Products Based on the VIX
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