NOTE: A big, sloppy welcome to all The Simple Dollar readers who discovered us this week. Unlike that site, where the comments are the only parts worth reading, here it’s the exact opposite. (Primarily because we don’t run comments. If you want to say something compelling or critical, try us here. Check out the archives, too. Reams of actionable, non-obvious advice and analysis for the upwardly aspiring. Enjoy.)
Can you handle another food/investing analogy? Well, you’re getting one.
The standard recommendation is to invest 60% of your portfolio in stocks and 40% in bonds. Or (110 – your age)% in stocks and (your age – 10)% in bonds. Or 57% in stocks and 53% in bonds (awesome if you can do it). All of the above are useless, pointless and unhelpful.
It’s like saying 40% of your daily caloric intake should be carbohydrates, 30% protein and 30% fat.
Okay, then let’s eat a diet consisting of 40% Gummi bears, 30% bearded seal meat and 30% lard. DONE!
You can’t look at classifications. They tell you nothing. You have to look at individual cases. Otherwise, you’d be forced to believe that:
-All pit bulls are dangerous
-All Jews are stingy
-All blacks enjoy grape soda
-All Armenians beat their wives
-All Canadians are sensitive.
Alright, that last one is demonstrably true.
Yes, we get the conventional wisdom. You’re supposed to be invested in equities when you’re young, i.e. when you can withstand greater variation in your investments. If you’re 22 and you get wiped out because you loaded up on Electronic Arts stock, the thinking goes that it’s not the end of the world because you have decades left in which to earn money. And if you bought lots of Recon Technology (a penny stock that’s up 4- or 5-fold this year, and will probably come crashing down to Earth soon enough), well, that’ll increase your options and require you to work incrementally less hard for a living in the long road ahead of you.
And when you’re old, you need to limit your downside – and by extension, your upside. No fancy swings for me, young man. Instead I’ll load up on debentures and other low-risk investments. I just want to come as close to a fixed income as I can. Now let me watch 60 Minutes in peace, and turn that damn music down.
No one should invest in asset classes. But people hear advice that’s easy to swallow, or at least easy to remember, and they say to the person in charge of their 401(k), “Put me in that one fund, with the 60-40 stock-bond split.” BOOM! Investing now completed! That was easy!
When you passively manage your investments – that is, when you get someone else to do it – you’re letting that person dictate your potential return. More accurately, you’re letting that person’s biases and instincts dictate your return. Here’s what we mean:
Your company’s comptroller has one overriding professional objective, and it has nothing to do with making sure you have a comfortable retirement. Rather, it’s far more mundane. Like most people on this planet, all he wants is to keep his job. Same goes for the fund manager’s representative who shows up at your workplace on open enrollment day. She could give a damn whether you sign up for the aggressive no-load fund or the generic income fund. She just wants you to sign up for something, and wants you to not lose so much money that it’ll jeopardize her position.
Further up the chain, the fund manager is playing it conservatively, too. Invest in too few blue chips, and you’re running the risk of higher returns. Which means you’re running the risk of lower returns, which if they come to fruition could lead to angry investors. Enough angry investors means the fund manager gets fired and has to do something else for a living, maybe even work retail in a building with fewer than 80 floors. Most fund managers would rather die, so they continue playing it safe, creating largely indistinguishable mutual funds that each do not-too-horribly. And everyone’s happy. The fund manager doesn’t have to worry about returns that are far from average, the Morgan Stanley or Ameriprise advisor doesn’t have to worry about losing your company’s business, the aforementioned comptroller thus keeps your company’s owner satisfied, and your future is now invested in a hideously complex 401(k) that includes minute amounts of hundreds of large companies, almost all of which will stay stable enough on balance to keep your investment from vanishing.
But you can do so much more. It doesn’t matter how old you are, what your sensitivity to risk is, or whether Dave Ramsey thinks your portfolio incurs a suitable split between stocks and bonds; underpriced securities (really, underpriced investments of any kind) are always there, and always available to whomever’s in the mood for mostly free money.
Buy individual stocks, not just mutual funds. Stocks with powerful fundamentals are always worth buying. And if you’re unclear, by “powerful fundamentals” we mean regular profits, little debt (or at least, debt that the company’s profitable operations can afford to cover), possible treasury stock, and a high ratio of assets to liabilities. If any of those terms sound unfamiliar, buy our book.
God’s greatest gift to the amateur investor is stocks whose prices have temporarily fallen for irrational reasons, yet whose underlying businesses still have those powerful fundamentals. When public pressure is on the stock of a healthy company like British Petroleum to fall (as it was a couple of years ago), or on Netflix to fall (as it was last autumn), that’s a buy sign if ever there was one. It’s the exact opposite of the recent love-in between dilettante investors and Facebook, a company awash in publicity but with no publicly verifiable financial data to speak of. Quite the opposite, in fact.
Unballyhooed is good. Temporarily beleaguered is good (accent on “temporarily”). But nothing substitutes for a strong set of financial statements. A mere $3 can get you on your way to learning how to add a little self-determination to your investing. And give you a chance to make far, far more than if you’re merely letting someone else pick out a mutual fund for you.