By CARL RICHARDS

Carl Richards is a certified financial planner in Park City, Utah, and is the director of investor education at BAM Advisor Services. His book, “The Behavior Gap,” was published earlier this year. His sketches are archived here on the Bucks blog.

Based on the e-mails I’m getting, I guess that the stock market is getting scary (again). Will someone please remind me why we’re surprised when the market has periods — sometimes long periods — of turbulence and even decline?

We have a word for this: risk. Sometimes, we swap it out with the word volatility. You hear people complain that the market sure seems volatile lately, or they use the market’s ups and downs as a reason (or excuse) for putting all of their money in cash until things “clear up.”

But here’s the deal: the reason that stocks are likely to return more over time than bonds, and bonds more than cash, is precisely because they are more volatile (risky).

When it comes to investing, risk and reward are related. It’s as close as we get to a fundamental law in finance. If you want or need a greater expected return, you’ll have to accept more risk. The times I’ve tried to skirt this law, it’s been painful.

So if we believe that risk and reward are related, then investing becomes a pretty simple exercise. You buy good things and hold on to them for a long time.

Buying good things is easier than it’s ever been. Diversified, low-cost investments, like index funds, are good things and seem to be available on every online street corner. Also, figuring out how much to put into stocks versus bonds or international versus United States investments has been made easier by the introduction of target retirement date funds that use low-cost index funds like the ones at Vanguard.

A great place to start would be using the Vanguard fund that matches your retirement goal, like the 2045 fund. Then there’s the option of taking your age and putting that percentage of your portfolio in a bond index fund or taking 100 minus your age and putting that percentage in a global stock index fund.

Like Vanguard’s founder, John Bogle, said, you could find advice that was better than this, but the amount of advice that was worse was infinite. If you need more specific help, find an adviser you trust who uses index or other passive investment funds to make more customized portfolios.

Now, just because buying good things has become simple and easy doesn’t mean long-term success is guaranteed. You can design the best portfolio in the world, make one behaviorial mistake and blow the whole thing up. This natural tendency to react to the endless stream of useless news we get from the financial pornography networks is hard to overcome.

Of course, we want to do something (anything!) when the world is coming to an end. The problem is that it seems like the world is coming to an end — a different end — every week. If it wasn’t, what would they talk about on CNBC?

So that is where this second part of my little plan comes in: after you have bought good things, hold on to them for a long time.

If you’re invested in the stock market, I’m assuming you believe that risk and reward are related. If you don’t believe that, or if you think that it used to be true but now the game is rigged, get out and stay out. You can’t have it both ways. If risk and reward are no longer related then there is no reason to invest in stocks.

So much of what we think of as investing would be recognized as little more than a fantasy of market timing when viewed in this light:

  • The idea that you can be in the market when it goes up and out when it goes down: Fantasy.
  • The idea that you can pick stocks that will go up when the market goes down: Fantasy.
  • The idea that your buddy from college who worked on a trading desk for years and has now started a hedge fund that uses a proprietary trading algorithm that can get the same return as the market with less risk: Fantasy.

The tricky thing about all these fantasies is that someone is always successful just often enough, for just long enough, to get a spot on television or to make the cover of a magazine. At that point, we’re enticed into believing we can get in on the action. Then, just about the time you think you have found investing Shangri-La, it disappears, right after you commit your capital to it.

Because we can’t have it both ways, if someone promises you higher returns, you need to ask the question: What’s the corresponding risk? If you can’t identify it, don’t be fooled into thinking it isn’t there. It is, and it’s likely to show up when you least expect it.

If you still believe that risk and reward are related, buy good things and hold on to them for a long time. If you no longer believe, then get out and stay out. The thing to remember is that either choice is O.K., but trying to do both is a very bad idea.

http://bucks.blogs.nytimes.com/2012/06/11/the-two-keys-to-investing-pickiness-and-persistence/

 


Tags: , , , , , , , , , , ,

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

Subscribe without commenting