Last week we addressed investors who have accumulated sufficient assets to have diversified into positions in Bonds and Foreign Stocks. No longer should these investors be considered novices, but they are far from experienced. As their accounts grow, more diversification can further spread their risk, as well as improving their chances of long-term success.
Today, we are examining expectations among investors. This may be the most controversial subject we have discussed to date. Many an investor is unhappy today because of his or her unreasonable expectations. Having an understanding of long-term investment returns and principles may save a lot of future headaches.
Things you need to understand include:
• You will not “beat the market,” so don’t try (more on this below).
• Individual stocks are very risky. Good things happen to bad companies, and bad things happen to good companies. Spread the individual stock risk through diversification.
• Annuities are not investments, but rather transfer-of-risk products. This does not mean that they are useless by any means. They solve certain problems for certain people, but are historically over-sold.
• Commissioned salespeople are not required by law to place your interests ahead of their own. Fiduciaries (such as Van Wie Financial) are required to place your interests first.
• The market always over-reacts to events, so don’t be a lemming and blindly follow. Greed and fear, when acted upon, cause investors a great deal of pain.
• Losses feel worse than gains feel good, so minimize losses for long-term success.
• Make a plan before you invest. A “starter” plan can be simple, but it must remain flexible to accommodate growth and changing personal situations over time. A Financial Plan is not a document; it is a process.
“Beating the market” implies that your personal returns would be higher that the major market indices, which are comprised only of Domestic Stocks. You may outperform common market indices over a short time period, but don’t count on doing that for too long. A reasonable goal for investors involves understanding and accepting both a targeted return, and corresponding risk, over a long time period.
The Dow-Jones Industrial Average represents only 30 very large companies. The S&P500 Index contains 500 large company stocks, and the NASDAQ Composite contains a motley assortment of over 2500 company stocks. They sample only the first of our seven Asset Classes, Domestic Stocks. True diversification into several asset classes renders irrelevant any direct comparison between stock indices and an investor’s portfolio.
Nest week we will discuss the necessary relationship between risk and return in various portfolios.
Van Wie Financial is fee-only. For a reason.