Over the past week, I have had meetings with one banker and two brokers representing different organizations. They were hard at work, sizing me up in hopes that I will choose to put more of my money and more of my father’s money to work with their organizations. I was hard at work sizing them up and attempting to understand both their motives and their underlying investment philosophies and how I could use that information to my advantage. It seems like a good time to organize some of my thoughts on investments and share them with you.
One author described the market as the sum total of the actions of millions of irrational pants-wearing simians. Even though these mad monkeys, believe themselves to be masters of the universe, they actually are in control of nothing. They live in a habitat in the zoo surrounded by a moat and a fence. When they see something on the other side of these barriers that they like, they all scream in excitement, jumping up and down while throwing their money into the air. Then they turn around and see something upsetting on the other end of their enclosure. Becoming frightened of the future, there is a mad scramble to pick up as much money as possible before it is all gone. Then these frightened apes sit on their personal pile of money in fear that another monkey may steal their loot.
You can’t control what is happening beyond the fence. You can choose not to participate in the insanity found in the monkey house. Instead act with restraint and reason, following the advice of Warren Buffett, “Be fearful when others are greedy and be greedy when others are fearful.”
I have used this quote from the opening of the X-Files on more than one occasion, “Trust no one,” well at least not until they have proven themselves trustworthy over an extended period of time. Unless you are paying a financial counselor willing to sign a fiduciary oath by the hour or a fixed fee to develop an appropriate financial plan for your family, you are dealing with a salesman. Even the best commission sales personnel who are working for you have mixed motives. The author of Freakonomics demonstrated that Real Estate Agents will take more time to sell their personal homes at a higher price than when working for clients. When working for themselves, the agent gets to keep all the extra money. They only get 7% ± of each addition dollar they put in your pocket, big difference.
If salesmen are working for a company that is trying to sell you their products, they will be motivated to offer the merchandise that pays them the highest commission whether or not it is in your interest to buy it. Money managers get to keep a set percentage of your money, every year, even if they lose all your money. Typically managed accounts charge 1% a year, but hedge funds can charge 2% per year on the balance and up to 20% per year on any profits. Whether dealing with a plain vanilla retail mutual fund or the most exotic international hedge fund, watch out, not only for sales commissions, but for all kinds of different fees from the wretched, inexcusable 12 B-1 fees found on “Class B” mutual fund shares to legal and accounting charges found in more sophisticated products.
People, listen to me! Just as no one is going to care more for children than their parents, don’t expect anyone to consider your money as important as their money. Whether you hire a fiduciary advisor or deal with a salesman of retail financial products working on straight commission, the responsibility for your money is ultimately—Your Responsibility.
Even though I am warning you to be careful when dealing with brokers and their kin, there are people out there who deserve your trust. One of my brokers has helped the family through some difficult situations, moving money that was needed immediately to pay funeral expenses and medical bills. This same gentleman also spent hours of his time dealing with an organization of incompetent bureaucrats that seemed intent on fouling up a situation that could result in serious tax consequences. He also worked with my attorney to straighten out some family trust related issues. I understand he needs to earn a living. While I am still responsible for my money and make the final decisions, I have given him a great deal more leeway than I have with any other financial representative. So far, he hasn’t disappointed me. Unfortunately, he is almost my age. That means he will be retiring before long. Then what?
The Bible tells us that in a multitude of counselors one can find wisdom. Consider something as trivial and unimportant as a football game that has been recorded for posterity by as many as 62 television cameras (2013 Super Bowl). Two different accounts of the same game written by different reporters working different organizations, might disagree on almost everything but the final score. However, even if you didn’t actually get to see the game, after reading a half a dozen articles on the subject, you will have a pretty clear picture of what actually happened.
Studying potential investments really isn’t any different. Talk to experts. Talk to your friends at work who might be a step or two ahead of you. Read the classics written by the masters. Read the free reports available on your broker’s web site. In time you will come to understand what investment philosophy will work best for you. Don’t be afraid to change your mind as you increase your knowledge. I learned early on that retail mutual funds sold by commission salesmen is about two steps away from flushing your money down a toilet. As a result, I decided to follow the path of the value investor, concluding it was foolish to pay someone else to loose my money. As my understanding of modern portfolio theory and the concept of an efficient frontier increased, I learned that low cost index funds and exchange traded funds offered by organizations like Vanguard are not only fine products, but the logical place for a novice investor to begin his journey to financial freedom. I always want to learn. The more tools I have in my kit, the more likely I will have the right tool for a particular situation.
There are only two ways that are likely to get you in big trouble when investing in the stock market. The first problem is termed, individual risk. If you have too much money in the shares of one company, you will get hammered if anything happens to that company. BP was a model of a well run company until there was an accident in the Gulf of Mexico. BP then lost about half its value in a matter of weeks. How much is too much? I would say if you have more than 10% of your portfolio in any one company, you are playing with fire. It gets even more complicated when considering companies in the same sector that move together. The major oil companies tend to move up and down with the price of oil. If you have shares in BP, Exxon, and Chevron that total 10% or more of your portfolio, you are still exposing yourself to individual risk. Understanding exactly what you have can be difficult. I own Chevron. The family trust owns Chevron and a number of my mutual funds also own Chevron. I couldn’t tell you how much Chevron I really own, but I do know it isn’t anywhere near the danger zone. Finally, some companies give their employees shares of the company stock. Again consider the risk of a large concentration in one company when you work for that company. If your employer gets in trouble, you could end up not only losing your job, but all of your retirement savings at the same time.
Investing too much money in the stock market at one time can cause problems. If you save and invest small amounts of money consistently over the course of your working life, you will buy fewer shares when the price is high and a greater number of shares with the same amount of money when the price is low. Over time, you can expect to receive that 7% predicted by Siegel’s Constant. There is no way to completely protect yourself from what is termed systemic risk, meaning the risk of a stock market crash, but whenever possible play with the house’s money. If, over good times and bad you have consistently bought a well diversified mix of investments, chances are you will survive the periodic downturns, as occurred in 2008. If you rebalance as the price of equities tanks, you will own a whole lot of shares when the market rebounds.
Maintain an age appropriate balance. Rather than considering your retirement portfolio, let’s look at a 529 college savings plan for your daughter’s education. When she is a new born, you open her account with $1,000. In the grand scheme of things $1,000 isn’t a lot of money and eighteen years will pass before she actually needs it. You can get a little wild and crazy, investing it all in stocks if you wish, with money in small cap stocks and foreign shares that would be well out of my comfort zone.
OK, you did good. After 17 years you have the $250,000 she will need to attend one of those exclusive private schools she is visiting. Now, we know that on average we can expect a 7% return on equities, but only 3.5% on bonds. However we also know that the world ends every ten or twelve years. Stocks can easily drop 40% or more in a given year. She needs the money next year. If you put it all in stocks, you can expect an extra $8,000 a year—on average. However, if you guess wrong you stand to lose $125,000. Then the little princess will be forced to attend that in-state public institution populated by beer drinking rednecks instead of the school of her choice. Is an extra $8,000 that you really don’t need to achieve your goal worth the risk?
Don’t need the market. If you don’t need the market to perform miracles on your behalf, you can choose the time you buy and sell shares. If you buy shares in a stock that hits a bad spell, you have options—if you don’t need the market. You can wait for a better time before selling the shares. If the company pays a righteous dividend waiting is not necessarily a bad thing. Your dividends are buying shares at a depressed price. If you don’t need the market, you can even buy more shares when the price is low, because you have free cash set aside for that purpose. If you decide the company isn’t coming back, you can choose the time to sell to maximize tax benefits, offsetting one of your gains with a loss. If you need the market, you might be forced to sell shares at the very bottom of a recession in order to pay your living expenses. This can be a very painful experience. During a crash, people can end up selling mutual funds at a loss only to be hit with a tax bill based on what happened earlier in the year, doubling the pain of a forced sale.
'Use money and love people. Don't love money and use people.'
Joseph Prince —
Remember the purpose of savings and investments. They are not an end in themselves. Money is just a tool. It can be used to bless your family and make the world a better place. It can also be wasted in a manner that will destroy your family and even take your life. You can’t take it with you, but on that day you will have to answer for the way you have managed money.
Now say it with me, “Let’s be careful out there.”
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