Did you happen to see the financial news this week? Did you think you should probably DO SOMETHING about it?
Some of the best, most rigorously developed financial advice is so obvious, it’s become cliché. And yet, investors often end up abandoning this very advice when markets become turbulent. Why the disconnect? Let’s take a look at some familiar financial tips, and why they’re often much easier said than done.
No risk, no reward
Don’t put all your eggs in one basket
Buy low, sell high
If you fail to plan, you plan to fail
I’ll explore each in turn and explain why helping people stick with these evidence-based basics remains among my most important and challenging roles.
1. No Risk, No Reward
In many respects, the relationship between risk and reward serves as the wellspring from which a steady stream of financial economic theory flows. Simply put, exposing your portfolio to market risk is expected to generate higher returns over time. Reduce your exposure to market risk, and you also lower expected returns.
Once you understand how market risks and expected returns are related, you’ll see that it’s critical that you remain invested for the long term — because risk and return play out over decades, not months and years. I typically allow for a measure of stock market exposure in my clients’ portfolios, with specific allocations guided by individual goals and risk tolerances. But here’s the thing: It won’t work out if the client can’t handle some measure of risk and bails out at the first sign of turbulence.
There’s ample evidence that periodic market downturns are part of the ride. Such risks ultimately shape the stream that is expected to carry you to your desired destination. Consider them part of your journey.
2. Don’t Put All Your Eggs in One Basket
The fact that you might need to include riskier investments in your portfolio does not mean that you must give them free rein. Risk is real; it is not a mythical unicorn. If it rears up, it can trample your dreams, especially if you’re holding a concentrated position in one or two stocks.
This is where diversification comes in. By combining widely diverse sources of risk, you can build more efficient portfolios. By diversifying your portfolio internationally and across market sectors, you’re spreading your risk (putting eggs into multiple baskets), making sure that a bad market in one country or one sector doesn’t hurt you in the long run. A good diversification approach can do one of two things:
- Lower a portfolio’s overall risk exposure while maintaining similar expected returns
- Maintain similar levels of portfolio risk exposure while improving overall expected returns
3. Buy Low, Sell High
Of course, every investor hopes to sell their investments for more than they paid for them. Unfortunately, many investors panic when the financial news is bad, and all too often they end up doing the opposite.
Sometimes, market setbacks are over and forgotten in days. Other times, they more sorely test our resolve with their length and severity. We can’t know how current events will play out, but we do know this:
- Capital markets have historically exhibited an upward trajectory over the long term, yielding positive, inflation-beating returns to those who stay put for the ride.
- If you instead try to time your optimal market exit and entry points, you’ll have to be correct twice to come out ahead; you must get out and back in at the right times. You can’t time the market, and it moves quickly – by the time you can see the trajectory of the market, it’s already too late.
Be wary of hyperbolic headlines bearing superlatives such as “the biggest plunge since …” While the numbers may be technically accurate, they are framed to frighten rather than enlighten, grabbing your attention at the expense of the more boring news on how to simply remain a successful, long-term investor.
4. If You Fail to Plan, You Plan to Fail
Almost everyone would agree: It makes sense to plan how and why you want to invest before you actually do it. And yet, few investors come to me with robust plans already in place. That’s why deep, extensive, and multilayered planning is one of the first things I do when welcoming a new client, including:
- A Discovery Meeting – To understand everything about you, including your goals and interests, your personal and professional relationships, your values and beliefs, how you’d prefer to work with me… and anything else that may be on your mind.
- “Traditional” Financial Planning – To organize your existing assets and liabilities, define your near-, mid-, and long-term goals, and ensure your financial resources align as effectively as possible with your most meaningful aspirations.
- An Investment Policy Statement (IPS) – To bring order to your investment universe. Your IPS is both your plan and your pledge to yourself on how your investments will be structured to best align with your greater goals. It describes your preferred asset allocations (such as your percentage of stocks vs. bonds), and is further shaped by your willingness, ability, and need to tolerate market risks in pursuit of desired returns.
- Integrated Wealth Management – To chart a course for aligning your range of wealth interests with your financial logistics: insurance, estate planning, tax planning, business succession, philanthropic intent, and more.
Even the most solid planning doesn’t guarantee success. But I believe the only way I can accurately assess how you’re doing is if we’ve first identified what you’re trying to achieve, and how we expect to accomplish it.
Why it can be hard to follow good advice
In my experience, as “obvious” as this advice is, it’s very hard to adhere to it in the face of market turbulence. Blame your behavioral biases. We all have them, and they make simple advice deceptively difficult to follow. In fact, because of blind spot bias, we can easily tell when someone else is succumbing to a behavioral bias, but we routinely fail to recognize when it’s happening to us.
It’s essential to have an objective advisor who is willing and able to let you know when you’re falling victim to a bias you cannot see in the mirror. That’s exactly what I’m here for! Let me know if I can help you reflect on these or any other challenges that stand between you and your greatest financial goals.