Investing in the stock market can be an excellent strategy for growing your hard-earned money into a larger pool of savings, particularly as pensions and company retirement packages erode. In the wake of the Global Financial Crisis and the market volatility that has followed, many new and potential investors view the market as a daunting, even dangerous, place to park their money.
Much of this apprehension stems from not knowing what to look for, who to trust, or where to start. Minimize this apprehension by educating your self about the industry and the key actors with whom you must engage. Start right here:
WORKING WITH ADVISORS
When it comes to portfolio management, the importance of with whom you’re working, and how you work with them, can’t be understated. Here are a few tips:
DO: Establish clear goals.
As an investor, you work hard to make money. You make sacrifices to save it. You invest it in the hopes that it will grow. You want to minimize expenses and maximize growth so that you can achieve your goals. All of this requires that you establish these goals ahead of time.
Start by asking yourself some simple questions.
- How much money do you need to maintain your current lifestyle?
- Do you want to modify that lifestyle in the future?
- Do you need to save for a mortgage? A child’s education? Retirement? Travel?
According to Suzy Orman the ideal advisor will help you firmly outline these goals before developing your portfolio or making a new investment, and will use them to help you plan realistic time horizons and appropriate levels of risk.
DON’T: Assume that bringing on an advisor means you can be hands-off.
Sure, you’re engaging the services of a financial advisor so that you don’t need to watch the market every waking minute, but hiring a financial advisor doesn’t mean you can ignore your portfolio. Your finances are important, both to your present lifestyle and your future security.
No matter how much you trust your advisor, you can’t follow his or her guidance without question. They are trained professionals, but being educated about the industry and your investments will benefit you. You also need to be an active participant in steering your portfolio. Without your input, your financial advisor can only guess at the direction you want to go. You need to have a clear, open, and regular dialogue with your financial advisor.
According to Gallup, “fifty-seven percent of U.S. adults overall are financially literate, with the U.S. ranking 14th in the world in financial literacy. U.S. adults have a relatively weak understanding of compound interest, the survey found. What this means is a good deal of us, over 40% are financially illiterate, according to their standard and when you include understanding of things like underfunded pensions, counter party risk, interest rate swaps and credit default swaps, I would venture it’s in the 99% range.
With that, understanding more about how things work at a maximum or keeping your investments as a top 4 priority at a minimum, After God family and the Green Bay Packers1 (your work) is extremely important. You do not want to miss opportunity year after year by setting and forgetting your investments. You could completely miss out on one of the U. S. Government’s great gifts, the Roth IRA!
DO: Choose an advisor who believes that planning is paramount.
When it comes to investing, it’s easy to miss opportunities to grow your investments more quickly or with fewer tax consequences because of the sheer size of opportunity. You and your financial advisor need to be on the same page. If anything, an advisor should be leading you through the process, helping you plan for all possible contingencies and opportunities.
The financial plan you establish forms the framework by which you and your advisor are held accountable. A proper plan will keep your portfolio on the right track and in line with your goals. It’s particularly helpful to understand that sometimes the investor’s savings is carrying the load and sometimes it’s the markets, because there will inevitably be surprises and fluctuations in both.
UNDERSTANDING THE MARKET
In order to evaluate, discuss, and trust the recommendations of your advisor, you need to shore up your understanding of the market. (you can do that here with us because) There’s a lot of misinformation out there (that Squire clears up) that can inhibit your investment outcomes, so:
DON’T: Believe everything you hear.
You know this. Your mother probably drilled it into your head a hundred times: “So if all of your friends jumped off the bridge, would you jump too?” Just because the financial industry tells you that something is good or bad doesn't necessarily mean it’s true. The common wisdom espoused by some of the financial advisors, investment banks, economists and especially pundits are marred by misinformation that, if taken at face value, could have a significant impact on your financial strategy. We call this Misinformation Risk™.
Whether it relates to market timing, crashes, or portfolio management, understanding misinformation and how it relates to industry practices can help you to become a smarter investor. If something doesn’t sound right, question the logic and don’t be afraid to ask questions or (ask your advisor to) conduct research.
Conducting critical research is incredibly important, and the source of this research is also critical: consider whether the author is benefiting from pushing a certain objective? Many professionals in the investment industry use fallacy laden arguments because they’ve been mistakenly educated to believe them themselves. They’re unaware of the fallacies because they often can’t recognize a fallacy in an argument or they may not even know what they are or that they exist.
Bottom line: You can’t believe everything you see or read. That doesn’t mean you should stop reading, only that you should expand your research as far and wide as possible. Look to history for clues about market trends and investor behavior. Ask questions. Study logical argumentation so that you can better recognize faulty logic when you see it.
DON’T: Place blind faith in academic studies.
Many people look to academic studies as definitive source material, but this can be problematic, too. Why? First, the definitions used in academia often differ from those used in the investment world. For example, “fair value” in academic parlance means the potential price of a stock set by a PERFECT MARKET. The term takes a much different meaning in the real market (which is not perfect), where it describes the value that an individual investor assigns to a stock based on an evaluation of the company’s financial information.
Secondly, academic articles may be based on small sample studies. They make assumptions, and annualize and group data in a way that seems authoritative but may not accurately reflect—or could even misrepresent—the way the market actually performs. This doesn’t mean that academic articles are wholly useless, but seek as many sources and perspectives (particularly counter arguments) as possible before making any determinations.
Third, and most definitely not finally, academic studies often cannot see every instance of or relating to the study at hand. For example, when you say it’s impossible to beat the market, you’re saying no one has ever done it and can’t. That is very hard to prove or even know when people are investing, both professionally and personally in their basements or home offices. It plays us, really, for idiots.
DO: Make use of someone who has great market research tools, like the Bloomberg Terminal.
The stock-screening software alone helps you filter through large amounts of data to find the information that is most relevant to the investments you’re considering. As a tool, the Bloomberg Terminal is much more efficient than researching points of data one at a time, stock by stock in the form of online 10k’s or annual reports. You don’t need to own and use it yourself, but you may want to consider working with at least one financial advisor that does.
By working with a financial advisor who is proficient with this software, they(for you) can comb through the entire market in a much shorter span of time. Not only will you have a much broader base of knowledge with which to work, but also the time to make thorough, considered decisions that will hopefully lead to more successful investment attempts.
Setting a financial plan, as stated above, is paramount. There are myriad strategies you can employ depending on your goals, but here are a few things to keep in mind:
DO: Diversify wisely.
Some diversification is wise, but studies show that once you increase the size of your portfolio beyond 10 stocks, the benefits of diversification become increasingly marginal.
The potential benefits are so marginal that what you’re actually doing is diminishing your chances for high returns on any of your investments. This is over-diversifying. And, if a downturn does hit, you’re invested so widely across the market that your portfolio is likely to take a hit especially during a crash. The diversification you thought would protect you does nothing beneficial.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.
DON’T: Be afraid of investing in companies.
A small, carefully selected portfolio of growth stocks (companies showing high growth potential) that change over time might help.
DO: Try to prevent massive loss in crash markets.
Proponents of the buy-and-hold strategy will tell you that you should remain invested in the market at all times. They’ll claim that if you don’t stay in the market, you risk missing the best 50 days on which you stand to make the most money. What they’re not telling you is that the best 50 days are often followed closely by the worst 50, and it’s far more detrimental to be in the market for those. 90% of both days come during crashes and Squire has found historically that parts of those crashes were avoidable.
Be wary of advisors that downplay the impact of crashes on your portfolio, or use S&P 500 data as their key evidence to illustrate historical trends. The truth is that it can take decades for your portfolio to recover, and the S&P 500 data set misses more than 30 years (Crash prone) of relevant market history. You and your advisor should formulate a plan for how to deal with market crashes in advance—decide when you will get out, and what exactly that looks like.
DON’T: Be afraid to take a step back.
Remember, you don’t need to be 100 percent invested 100 percent of the time.
In fact, this can be a hindrance. If you’re 100 percent invested, you’ll need to sell some of your assets in order to buy others when an opportunity to buy low arises. The problem is that it may not be the optimal time to sell those assets, and buying low is only effective if you’re also able to sell high. Make sure you have cash set aside for future investment opportunities.
Investing in the stock market is like driving a really nice sports car. It’s fast, it looks great, and it can be a lot of fun. But if you drive recklessly, your speedy sports car can kill you. Similarly, if you invest recklessly, you can miss opportunities or inhibit your ability to capitalize on them. If you anticipate a market turn and act too quickly, buying or selling well before the market has hit top or bottom, you may end up incurring losses or realizing lower returns. Slow down. Step back. Take your foot off the Gas Once in a While. Evaluate. Then act.
- Vince Lombardi and Jim Valvano
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Stock investing involves risk including loss of principal.