Thursday, February 27, 2014

2nd Law Investing

Back in the day when I worked in a Government laboratory from time to time we would receive unsolicited proposals. Some of these were from well intentioned people with (shall we say) an excessively active imagination. Some of them were attempted fraud. We received a proposal from a person located in Pakistan who claimed he had developed a machine that would produce a greater output of energy than the amount of energy required to run the machine. Basically, what he proposed was a magic box, called a perpetual motion machine of the second sort. This class of device violates the second law of thermodynamics. No device will ever break even. It will always lose some energy through waste heat. Your automobile might be 30% efficient. That means 70% of the energy generated by burning gasoline is waste heat. A really large marine diesel might raise the ante to 60% efficiency, but sadly the 2nd law of thermodynamics tells us you will never reach 100%, let alone 200%. The man from Pakistan told us he would show us what was in the magic box if we gave him $50,000 in cash. Fortunately the Government declined his generous offer.

If someone promises you get rich quick returns on some investment or method of investing, it is likely that you are looking at a charlatan attempting to separate you from your money. There are no magic boxes that work consistently over long periods of time. Yes, someone will win the lottery, but lottery tickets are not a sensible method of investing for your retirement.

Ask yourself these kinds of questions:

1)If this guy is so smart why isn’t he rich?

2) If this guy has a magic box why doesn’t he just use it rather than offering to share it with me for a fee?

3) If this guy is not telling me a bald face lie, how much time and effort will it require to get the kind of results I want? (Think MLM schemes. Do you really want to alienate your friends, family, and neighbors in an attempt to get rich selling some overpriced product?)

4) What isn’t this guy telling me? Usually you aren’t hearing anything about sales commissions, taxes, or brokerage commissions.

No investment or investment class will work for all time in every environment. Real Estate goes up. Real Estate goes down. The stock markets go up. The stock markets go down. Gold goes up. Gold goes down. There is nothing that will provide consistently high returns with little or no risk in every market situation.

The only way to build wealth with a high probability of success is slowly by investing in a diverse, age appropriate portfolio over a lifetime or in the case of multi-generational wealth over several lifetimes.

Don’t be afraid to pay a professional for advice, but make certain of his credentials and make even more certain he is not a commission salesperson. Commissions are typically structured to benefit the company offering the investment product, not the client’s best interests. Mutual funds with a sales load typically get more or less the same kind of returns offered by similar no-load funds, but if you have lost 5.75% in sales commissions your $94.25 will need to earn 6.1% more than the $100.00 in your neighbor’s no-load fund—just to get even! There are fee for service investment professionals who will design a personal investment plan appropriate for you, your goals, and your particular situation. There are reputable investment newsletters, although most of them are junk. The good ones are a fine place to begin your investigations of individual stocks or investment strategies. You can tell the good ones. They offer no guarantees of high returns with little or no risk. They don’t play on fear and greed. They say things like, diversification in quality assets, plus dividends, plus time offer a high probability of putting the power of compound interest to work for you and your family.

Ultimately, you are responsible for how you choose to invest your hard earned money.

Keep in mind that the purpose of investing is not to get rich. The purpose of investing is financial freedom, a component of a good life that glorifies God, provides for your family’s needs, and leaves you with a little something left over for your personal enjoyment. Money is just a means to an end. It should never be an end in and of itself.

Now, “Let’s be careful out there!”

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