The Emperor Wears No Clothes, Part 7: What to Do
In my last six columns, I challenged many commonly accepted “wisdoms” and methodologies in the investment industry. I also highlighted some customer contributions to the problem. Now it is time to answer the question that so many of you have asked, “What should I do?”
First and foremost, you must devote time to learn investment fundamentals. How much time? Allocate enough to understand and be able to apply your judgment in any major investment decision. I assume that you do not delegate major business decisions to your attorney or accountant. You get their professional input and apply your knowledge, judgment and common sense to make a decision. If you are investing a material amount of money, you should give investment decision making the same level of attention.
The Right Help
If you want expert help, you must take the time to understand the pros and cons of each type of organization available to play that role. Whether it’s a wealth management firm, investment consultant, money manager or astrologer, look for a person or firm that:
Is demonstrably interested in and willing to work towards your objectives, as distinguished from one who is trying to sell you a product or cookie cutter approach;
Has substantial experience working for clients with your level of wealth;
Has “skin in the game” (meaning has their money invested side-by-side with yours);
Avoids conflicts of interest (be cautious with firms that directly or indirectly profit from the investment decisions that you make);
Is not subject to pressures from his own or an affiliated organization to act contrary to your interests (e.g., to meet sales, growth or quarterly earnings targets; sell specific products; etc.);
Is thoughtful and willing to challenge commonly accepted wisdoms;
You expect will be in around for a long time (avoid organizations that are being built for sale or have a revolving door for personnel);
Willingly takes the time to explain difficult concepts and educate you on an ongoing basis;
Offers a level of customized service suited to your needs;
Understands the importance of taxes and can enunciate how he will act to address them in the investment process;
Has core philosophies that are consistent with your own; and
Demonstrably operates with great integrity.
Beware of salesmen. The industry is chock full of them and many are excellent at their trade. However, salesmen per se don’t generate investment returns or reduce risk for you.
Try hard to look beyond their hype. Fancy charts with lots of numbers and statistics are not very meaningful predictors of future performance. Everyone will tell you that they are the best and will carefully select the statistics and measures to prove it. When you sense a sales pitch, reread the above bullet points.
After your education, you should work with your most trusted advisors to develop a long-term, comprehensive plan based upon your objectives and risk tolerance. Don’t start investing until you have. It should include a strategic asset allocation and be integrated with your tax, business and personal plans and objectives.
Carefully consider how you will react to significant market swings. If you think that a large swing, either up or down, will cause you to depart from your plan, then you probably haven’t come up with the right one. The best way to avoid fear (in down markets) and greed (in up markets) is to start with a plan and then stick with it. Fear and greed may well be the worst enemies to achieving investment success.
You must begin to think long-term in the operation of your investment plan. For example, you should measure success or failure over market cycles, meaning years rather than months or quarters. Making major changes, like abandoning stocks when the market crashes, is a classic mistake.
Want another example? Fire your consultant if he recommends canning a manager that he chose nine months ago! Just as the success of your overall plan cannot be judged in a short time, managers generally should not be judged based upon short-term investment performance (assuming that they are sticking to the discipline for which they were chosen).
Focus on risk. Of course, you must take risk to generate returns, but thoughtful investors carefully assess the types and amounts of risks they are willing to take. They judge the return opportunities in the context of the risk exposure avoid unnecessary risks and actively seek to mitigate them. That is a very different mindset from chasing returns.
It is short-sighted to invest in things with a bad risk/return ratio. Remember that what is hot today likely is expensive. What is out of favor likely is cheap. In the investment world, markets can be irrationally priced, sometimes for a long period of time. However, rationality typically returns. Over time, prices swing like a pendulum, which tends to return from the extremes to the center. Capitalizing on this concept means you have to be disciplined enough to:
Be circumspect about investments that everyone seems to be buying (since demand drives prices up),
Pare back on your top performers, taking some money away from an asset class, manager, industry, etc. that has performed remarkably well (selling when demand has driven up prices),
Consider buying what is out of favor today (when it’s cheap, it’s time to buy more), and
Above all, remain diversified both within and across a wide range of asset classes.
Unfortunately, these are challenges that most people can’t handle, because it takes self-control to sell and buy at the opportune times.
Well, I didn’t say it would be easy, nor did I suggest that I have a surefire way to make you rich quickly. If I did, I would be writing these articles from an exotic location.
If you approach investing with the discipline and attention that you give to your business, seeking advice from the right people, your odds of success can be greatly improved. I wish you “good luck,” but I trust that you now understand that serious investing requires much more.
Ross Nager is Senior Managing Director
of Sentinel Trust Company of
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