My 30-year old nephew, who is a really trendy and cool guy, has been asking me for
investing tips
for the past five years. But as much as I love him and want to help, I hate it when he
does that.
Why? Because the conversation always goes to the same place; namely, he has heard or read
about
some great idea, and wants to change his investment approach. After discussing it for a
few minutes,
I always end up saying that he shouldn't change his strategy -- he should stick with the
policy that
has brought him success thus far.
And in his eyes I can read his thoughts: "My uncle is really boring."
Believe me -- I want to be exciting. I want to be able to look him in the eye and tell him
"now is the
time to buy junk bond funds!" or "financial sector stocks are really hot right
now!" But you see, I
like the guy, and I want him to do as well as he can. So I remind him that a lot of
thought went into
building his financial plan, and his goals are long-term, so he should continue with the
investment
plan he started.
The two most important things you can do to achieve success in reaching your investment
objectives
are to:
invest as much money as you can, and
stick with your plan.
At first glance you might think that you can't do too much harm by switching around your
investment
strategy -- i.e., "playing the market." For example, suppose you think that next
month international
stocks will do well, so you shift a lot of your investments from domestic funds to foreign
stock
funds. Sometimes you win and sometimes you lose, so in the end, you break even, right?
Wrong!
While winning half of the time and losing half of the time will not change your average
return, the risk
of your overall portfolio will go up. My research has shown that the increase in risk can
be as much
as 50% -- the highs will be 50% higher, and the losses will be 50% greater.
But more importantly, when investors switch investment strategies, they tend to lose more
often than
they win. Research shows that even sophisticated institutional investors tend to make poor
timing
decisions. And individual investors make abysmal timing choices.
Here's the most recent example: investors in 401(k) plans moved an aggregate 9 billion
dollars out
of equity funds and into bond and stable value funds as a result of the decline in stocks
during
August 1998. Over the next four months the stock market earned 29%, meaning that those
investors cashed in their equity funds at the bottom of the market, and missed out on
increased
returns.
Yet we continually hear people talking about changing their investment strategy. And we
frequently
read magazine articles about new investing ideas. It is reasonable to ask why so much
attention is
devoted to change, when consistency is supposedly so important. The reason is that people
talk
about what excites them, and editors tend to publish stories that titillate their readers.
The status quo
is seldom compelling. When was the last time you bought a publication headlined: "We
recommend
no change!"?
No, only fans of avant-garde Eastern European films find entertainment value in monotony.
But of
course, the goal of an investment plan is not to entertain. Idle chitchat with friends and
blurbs in the
press should not drive your investment strategy.
So while it is advisable to monitor your mutual funds to verify that they are maintaining
their
performance goals, and to update your financial plan to make sure you are on track to
reach your
goals, I caution you against meddling with your overall investment strategy. The path to
success is
paved with "consistency" -- and your objective should be success, not
excitement.
Now if you'll excuse me, I've got to run. I promised my nephew I'd take him to see this
new
Hungarian flick about the life of a dandelion. Lummer's
Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
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