Investing isn’t easy. Between magazine headlines and cable TV, what passes as financial advice can sound contradictory and confusing. On top of that, it can be flat out wrong and misleading. So how can we separate the wheat from the chaff?
It helps if we have a clear understanding about investing fundamentals like risk, active management, and market timing. Once we understand the basics, it becomes much easier to see most of this advice for what it is—a waste of time. Over the coming months, we plan to discuss these eight fundamentals to help filter out the good information from the bad.
1. There is a direct connection between risk and reward.
I understand that investing would be easier if we could separate the two, but we can’t have reward without risk. The flip side is that with risk we increase the odds of reward. Risk isn’t necessarily bad as long as we understand that it exists and why we’re taking it. We also need to remember the connection between risk and reward if someone tries to convince us that we can earn double-digit returns with no risk. Remember: the greater the reward, the higher the risk.
2. No one knows what will happen tomorrow.
If we invest based on what we “think” will happen, we’ll find ourselves chasing the market and coming up short every time. Most financial professional who speculate with their clients’ money (e.g., guessing about tomorrow) end up under performing the market averages. Run, don’t walk if someone tells you predicting the market is possible. Market predictions often rely on past performance and we know that past performance isn’t a guarantee of future performance.
3. There is no correlation between paying more and doing better.
In fact, the opposite is true. For example, if a mutual fund has high internal costs, the research shows that the outcome is poor performance. It’s hard to wrap our heads around this one because of the old saying, “You get what you pay for.” But in this instance, don’t assume that a bigger price tag means investments will perform better.
4. It’s not easy to find the next Peter Lynch.
Every year there seems to be somebody that the financial press identifies as the next hot fund manager. They’ve had several high-performing quarters, and we think to ourselves, “If I could just get in on the next one, I’d be set.” The problem is that just as most fund managers suddenly become hot, they could just as easily have a bad quarter. Our goal isn’t to find someone who can predict the market (see #2), but to find an advisor who helps us make smart decisions.
5. By a pretty wide margin, active management under performs the passive approach.
You’ve probably heard me discuss this once or twice, but it’s worth repeating. Adopting an active management strategy isn’t a realistic option for the average investor. Sometimes the returns make it look really attractive in the short term, but when we consider a big enough window of time, say 10 years, passive investing generates better results for investors.
6. You need a good relationship with your advisor.
What type of relationship do you have with your advisor? Do they really know you or are you just a number? One of the reasons we want to work with an advisor is because they know us, our goals, and what we really value. Make the effort to connect with an advisor that wants to connect with you. It’s not acceptable for your wants and needs to be ignored by your financial advisor. We all deserve a meaningful relationship that helps us reach our financial goals.
7. We need a long-term plan.
The time to create a plan for the next bear market isn’t in the middle of a down period. If we’re serious about making smart investment decisions, then we need to play the long game. To handle the ups AND downs that come with investing we need a long-term plan that takes both scenarios into account and helps us enjoy the highs and survive the lows.
8. Humans don’t make the best investors.
Investing doesn’t come easily to most people because we’re inclined to make decisions based on emotion. A prime example is buying when the market is high and selling when the market is low. But once we identify these bad investing behaviors, acknowledge that we have a problem, and take steps to avoid them in the future, we’re that much closer to achieving our financial goals.
I doubt any of these fundamentals surprise you, but hopefully they’re valuable reminders about what really matters for investing success. I look forward to discussing them with you during the next few months and hope that the next time you’re distracted by a financial headline, you’ll have the context to weigh its true value.