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Archive for October, 2011

Who Are You?

“If you don’t know who you are, the stock market is an expensive place to find out.”

My first mentor in the investment business said this to me in 1972.  At the time, I didn’t really understand what he meant, but over the course of the next 10 years or so I began to figure it out.  Perhaps you have figured it out, too.  But for many investors, it’s a concept that remains elusive.

The significance of the above statement is that investing is a full-contact sport, and one that shouldn’t be played without a helmet, pads, and mouthguard.  Too many investors step onto the playing field unprepared for the shellacking that they’re about to receive at the hands of the professional traders, and other investors who have done their homework and know how to take advantage of the weaker players.

In most of life’s games, this “learning from your mistakes” approach is perfectly fine, since most of us navigate through life by trial and error.  But when it comes to the investing game, every rookie mistake you make costs you real money, and a lot of it.  Not only that, but the time you squander while getting your investment education is time you will never get back.  At ZenInvestor we have a better way get your investing education – one that won’t cost you a fortune in time and money.

The DIY (Do It Yourself) Investor

When corporations began to abandon the idea of providing a pension (defined benefit plan) to their loyal employees, and started transitionitioning to ‘defined contribution’ plans, they ushered in the era of the ‘do-it-yourself’ investor.  But there is a fundamental problem with this.  Most people are ill-equipped to make consistently sound investment decisions over the long term.  And it’s not because they lack the necessary intelligence.  It has more to do with the fact that our brains are set up to use estimation and rules-of-thumb to navigate through the complexities of the world.  Estimation is an extremely valuable skill, and it has served us well as a species in most aspects of life.  Using rules of thumb saves us time, and allows us to make quick decisions and then move on to the next problem.  This works well for most of the activities that we encounter, but when it comes to making investment decisions, it just doesn’t work very well.  Let me give you an example.

Poor Timing

One of the most common rules of thumb that investors use is extrapolation.  How do you decide which mutual fund to buy when it comes time to allocate your 401k contributions?  Most people look at the funds available in their plan, and pick the one or two that have done the best over the past 3 to 5 years.  This particular rule of thumb says that if a mutual fund manager has done well in the past, he or she must possess exceptional skill, and there’s no reason why they should not continue to perform well into the future.  But studies have clearly shown that past performance is not a good predictor of future returns.  In fact, most studies show that the longer a mutual fund manager beats the market, the more likely he or she is to underperform in the next one, two, and three years.  So basically, you are buying high, and when you get tired of the fund underperforming year after year, and you give up on it and sell, you have probably sold at or near the bottom.  Buy high, sell low.  Not an effective way to manage your investments.

Start With An Honest Self-Assessment

How did you do in the market last year?  How about the year before?  Did you sell stocks in 2008?  If you did, are you still on the sidelines, or did you get back in?  What’s your track record since you first started investing?  When you calculate your results, do you include everything on your statements – like contributions and withdrawals, fees and expenses, and accounts that are inactive or have been closed or moved?

Are you the kind of person who makes investment decisions in a rational, thoughtful way?  Or are you a gunslinger who depends on instinct to pull the trigger?  Do you like to pick individual stocks, or do you prefer mutual funds?  Do you know what your asset allocation breakdown is?  Do you monitor and rebalance your accounts regularly?

Do you look to others for your investment ideas, or do your own research?  How much time do you currently spend on your investments?  Do you enjoy the investing process, or would you rather spend less time on it?

What percent of your income are you currently saving?  How many years do you have until you will start tapping into your nest egg?  Do you have a number in mind for your final nest egg?  What percent of this final number do you already have saved?

How big is your investment account?  How much is taxable vs. tax-deferred?  What tax bracket are you in?  When you add up all your commissions, fees, and other investment expenses, what is your total cost as a % of your total assets?

These and many other questions get at the heart of who you are, from an investor perspective.  By knowing who you are, you can see where to focus your attention and energy as an investor. Once you have done a full, honest evaluation of who you are, you’re ready to take the next step – figuring out how much risk you’re taking, and how much return you should expect as  fair compensation for the risk you take.  Most investors can reduce their overall risk level (by a lot) and improve their results (also by a lot) by putting together a simple, clear plan and sticking to it through good times and bad.  If you would like to learn more about what’s involved in making your own plan, ask your financial professional.  If you don’t get a satisfactory answer, visit us at ZenInvestor.org and ask for our free planning guide.