Investing 101: Six Things That Really Matter
John Oliver recently did a spot on his HBO show “Last Week Tonight” which highlighted the high fees paid by investors in 401(k) plans. As entertaining as his show was, it got me thinking about the things that are really important for investors to understand.
Never invest money you can’t afford to lose. If you need to tap your savings for immediate needs (like groceries or rent) or are saving up for a big purchase in the near future, then you can’t afford to invest those funds in something with a risk of loss. But if you are able to set aside some money for the long-term (and you can afford to replace it if your plan doesn’t work out), then you are ready to invest.
Start early. In order to accumulate enough savings to support your needs later in life, you need to start saving early, allowing your earnings to compound and grow over time.
What do you have in your portfolio? 30 or so years ago, groundbreaking academic work showed that how your portfolio is allocated (between stocks, bonds and cash) accounts for over 90 percent of the volatility in your portfolio. It also makes a huge difference in how your portfolio performs over time, but the intuition here is that the more stocks you have in your portfolio, the more ups and downs you’ll experience.
Costs matter. Let me put it this way. Many financial advisors use lots of different factors to try to pick the best mutual funds for their clients. Some look at investment style, some look at how long the manager has been with the fund, and countless other metrics.
Research has shown that the ONLY factors that is consistently associated with better performance is low fees.
Another aspect of costs that is frequently overlooked is the costs of trading. Every time you buy or sell an investment, you create transaction costs and potentially taxes. These costs are an additional drag on your investment returns. The more of your earnings you spend on fees and taxes, the less money you have growing to support your future.
Few managers consistently beat their benchmarks. This is another one of those awkward truths to investing: few mutual funds (or wrap account managers) beat the indexes they track. Standard & Poor’s (publishers of the S&P 500 Index of large US companies) publishes a quarterly report which looks at fund managers who did well over a given period (for example, from 2009 to 2012). They then look at how those same managers perform in the next period (2012-2015 in this example). What they find (repeatedly) is that just because a manager did well over one period doesn’t mean she will do well in the next period. Being number one for the last three or five years has nothing to do with whether that fund will do well in the next three or five year period. Past performance does not predict future results.
Markets are unpredictable. John Maynard Keynes once wrote that the stock “markets can stay irrational longer than you can stay solvent.” Markets are made up of human investors, and we are emotional beings. Fads can last longer than you expect, and markets can rise or fall more than you predict. Given that the best economic forecasters on Wall Street only get about 40 percent of their predictions right, most of us will do better just being in the market and riding through the ups and downs, rather than trying to time an entry or exit.
To paraphrase Woody Allen, 80 percent of successful investing is just being in the markets.
This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is director and chief investment officer with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management. Brooks can be reached at (858) 755-5166, or by email at brooks@bfadvisors.com. Brooks and his family live in Mission Hills.
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