FRIDAY, JANUARY 26, 2018
There are many strategies an experienced financial advisor can leverage to help clients achieve financial independence. There are also serious mistakes your advisor can help you prepare for or even avoid. Join Prism Insurance Agency to learn about, what’s considered by some, the 7 deadly sins of investing and how to recognize these missteps to help you become a more informed investor.
JIM: Today we’re going to talk about Seven Deadly Sins of Investing with Kathy Kristof, who is an award winning financial journalist and columnist for Kiplinger’s Personal Finance, as well as the author of Investing 101, and Complete Book of Dollars and Sense. Welcome Kathy.
KATHY: Well, thank you so much.
JIM: It’s great to have you one. You just recently wrote an article about Seven Deadly Sins of Investing. How can recognizing these missteps make you a better investor?
KATHY: Well, I think with any problem, knowing what it is, and what’s causing you to act irrationally, is a key to actually solving it. We see what we’ve done in the past. We know the problems that beset our friends and colleagues by just having that information available. I think it’s far easier just to walk in a different direction, spend a little bit more time being logical rather than emotional, and that can make you be a much, much better investor.
JIM: And I think that’s key. One of the First Deadly Sins that you talk about is not following the herd. I get clients coming in all the time saying they just got this tip from the person in the lunchroom, or a family member, and typically I find, by the time they’re getting stock tips across the fence line or in the lunch room, usually the money that’s to be made has already been made.
KATHY: Yes, it’s investing through a rearview mirror really. When you follow the herd; first of all, you don’t know where the herd is going, and secondly, you are attending to follow a group that has gotten up a lot of momentum, and maybe right at the point of going off a cliff. So, really the thing you need to do is have a plan to start with, and when people are stampeding in one direction, take a deep breath, and figure out why they’re going that direction, and whether you are comfortable with where they’re going, but if you’re following without really having a good concept of even what they’re doing, you know that you’re handing your money to somebody who’s going to lose it.
JIM: We’ve had two very good examples in the last 10 to 15 years of that. People forget the big term in the 90s, was Y2K. How many people flocked to tech stocks, only to watch that bubble burst, and people lost fortunes, and then just recently I had family members coming to me saying how they’re going to flip some houses in real estate, and lots, and all this stuff because everybody was making such a killing in real estate, while when you had unsophisticated people that have never really invested in real estate beyond their home getting into it, we knew there was another bubble coming, and look what happened there. So, you really got to be careful of following the herd, as many people have learned over the last 10 to 15 years. So, what is the danger now of giving into fear, which might be kind of the opposite of quick jumping into the tech stocks, or the real estate. What about giving into fear?
KATHY: It’s following the herd in the other direction really. You just mentioned a couple of the big bubbles, and when they pop, they pop with kind of an explosive problem for investors. You had $100,000 yesterday, and today it’s only 50, and for most people, you can’t take that kind of a loss, certainly not overnight. And so then, they get incredibly scared and want to walk away from the market. They want to sell it at the nadir, and never get back in. It tends to be that what happens, is of course, the market is manic depressive. It’s always been manic depressive, and so it has a tendency to go too far in the high side, and go too low on the downside. And if you react emotionally to any of those swings, you’re going to get killed. And so, what people will do when they give in to fear, is they put all of their money in safe secure investments, and in the end, they end up losing money to inflation, and so it’s as bad a decision as following the herd on the up side.
JIM: And the problem is, when they choose to do that, they’ve already locked in their losses before they do it. I’ve had a lot of discussions with people when we talk about their family homes, and they’re all in panic, because all of a sudden home values are down, and I said well, are you selling today, and they said well, I don’t know now that the values are down. I said, well when you bought the house, what did you buy it for. What was the purpose. It was to give her shelter when it’s sunny out. You put the air conditioning on, stay cool. When it’s cold out you can put the heat on. When it’s raining out, you stay dry. Is it still providing you all the things you expected it to? Well, yeah. Well, then what difference does it make what the value is if you sold today, because if it’s still offering you what you wanted or what you planned it for, then don’t worry about it over time. The value of that asset is exactly the same as when you purchased it from what it’s providing for her. So, having clear cut goals and understanding that, and keeping your eyes on the prize so to speak, I think is really key. I’ve seen so many clients make this mistake, and that is, hanging on to something too long. Especially, it was just last week, I met with a client. They had a stock and a pretty good percentage of their overall portfolio was in one company, but they had inherited the stocks, so it was like a family heirloom. They weren’t looking at it as an investment. So, talk about the risks of hanging on too long.
KATHY: Well, it’s like anything else. You have to look at the underlying value of an investment, and whether you feel that it’s reached its peak potential, and it’s time to move on to something that has better potential. If you’d been investing in tech stocks in the 1990’s; I know I was out there sounding like an idiot in 1999, telling people that tech stocks were overvalued, and that you should get out. Actually, stocks in general were overvalued, and you should get out, and everybody was looking at me like I was some sort of a nut case, because everybody else was piling in. But, in reality, if you looked at the underlying value, you said, gee, these companies are trading at a ludicrous multiple of five year from now earnings, which were so speculative, there’s no way to contemplate, and that was a big red flag, if you were looking at it critically, but if you weren’t looking at it critically, you held on to those stocks and you rode them all the way up and all the way back down. In some cases, into bankruptcy.
JIM: Well you know, in this recent financial crisis, I won’t say the name of the company or the stock, but in my area, we had a lot of clients investing in a particular bank. It was one of the banks that got hit pretty hard. People looked at the history and said, geez, I made a lot of money all the way on the up side, and one thing that we’re always lecturing people on is, the importance of being diversified. Don’t put too many eggs in one basket. Even good companies can have problems that are outside the realm of their control, whether it’s an environmental situation. It might be a market situation. There are a lot of different things that can impact these companies, but they rode it right down to where at one point, it was at $78 a share, and a few months later it was $3 a share. We saw the same thing with Enron. It used to be a darling of Wall Street, and all of a sudden it wasn’t there. So, you’ve got to be careful. You’ve got to be willing to take your winnings. You’ve got to be willing to cut your losses, and really, it all comes down to having a plan, and one of the things that you talk about in the Seven Deadly Sins of Investing, and I’m a big fan of this, and that is the importance of rebalancing. Share with us, what that’s all about.
KATHY: Really, it’s just that when you’re overall portfolio is probably in a whole bunch of different asset classes; stocks, bonds, cash, international, and you set up that mixture of assets for logical reasons. Because different investments address different goals most effectively, and you did percentages that said okay, or amounts that said this is how much I need for this goal, and this is how much I need for that goal, well the market is going to knock your very logical plan out of the water on a regular basis, because each investment category is going to move at a different pace. So, you need to at least once a year, take a look at your portfolio and see if those percentages still match what you set up in the beginning, or where they should be now, and if they don’t, you need to take money out of the winners, and you need to put them into some of the losing categories. And, while this is counterintuitive, it is actually putting into action buy low, sell high. You’re selling some of your winners, you’re buying some of the investments that are cheap. Over a long period of time, that’s going to make your overall portfolio both more stable, and appreciate in a better, more stair step sort of manner.
JIM: We’re talking about the Seven Deadly Sins of Investing, and we’re going to take a short break, and when we come back, we’re going to cover a few more of those Seven Deadly Sins that you want to make sure you have a plan, you have an investment philosophy and you stick to that philosophy, so please stay tuned.
JIM: Welcome back, as we continue to visit with Kathy Kristof, and award winning financial journalist and columnist who has been featured on many different magazines, television shows and I just got to ask you, who is Sylvia Porter?
KATHY: Well, she’s somebody that our grandmothers were very impressed with. She actually launched personal finance reporting way back in the 1930s, and she consulted with the government, was instrumental in creating savings bonds. She was an incredibly influential financial journalist, and when she died in 1991, I took over her syndicated column which was published all over the country.
JIM: And that was part of a once famous Jeopardy question I guess, right?
KATHY: Yes, it will be on my epitaph. I was a very young journalist at the time, and had just started writing a personal finance column. Her syndicate called me, and said hey, what do you think about doing this? I was scared to death.
JIM: Congratulations. Most of us can’t claim to being an answer on Jeopardy, so that’s fantastic. So, I appreciate you sharing that with us. Let’s talk about avoiding the mistake of making things too complicated. What do you mean by that?
KATHY: Oh gosh. So many people think to be diversified, that they need to have a vast array of investments, and so they’ll buy a dozen mutual funds. I have seen portfolios that literally had 40 or 50 different funds, and the person tends to come to you when they’ve blown up all at the same time, and they’re like wait, I thought I was diversified. Well, you’re not diversified if you’ve got 50 different funds but they happen to all be in the same category. What you really want is a simple portfolio that you can say, I’ve got some stocks, I’ve got some bonds, I’ve got some cash. I’ve got some international investments. I’ve got some real estate. That mix is going to give you diversity, but you can do that mix with one fund, like a target date fund. You can do it with five funds, with index funds in each of those categories. Or you can do it with actively managed funds, but when you get too many funds, it’s unwieldy, it’s hard to manage, and it’s hard to know what you’ve got. It’s hard to know exactly what asset classes you have, and that can make it more difficult for you to diversify, and certainly can make your tax situation a nightmare.
JIM: Absolutely. I know with mutual funds, there’s tools available that look into overlap, so if you had 10 different funds, you can plug that in and a lot of times you’ll find out their mix is almost the same stocks and bonds, because they all get a lot of the same research, so making sure that you have a truly diversified portfolio, doesn’t need to be the complication of 50 different mutual funds. I know prior to the stock market decline in 1990, 2000, 2001, 2002, sometimes they talk about style drift in the mutual fund industry and I can think of a couple of families of funds, where they were chasing the momentum of the 1990s, and all of a sudden you had mutual fund portfolios that kind of drifted away from the style, and they all started to become one big mutual fund, even though they had three or four different categories. They investors had four or five different funds with the company, and they all went down the same, because they all drifted into the same investment philosophy, chasing that momentum, so it’s really critical when you invest in those funds, is understanding how they invest, and what’s in the portfolio and making sure that you may think you’re getting diversification, but making sure you’re truly getting that diversification, right?
KATHY: Yes, absolutely.
JIM: Let’s talk about another thing. How important is the difference in fees that you pay annually?
KATHY: Oh my gosh. This is one of the most important things you need to pay attention to when you’re investing. Because in reality, the performance difference between one fund and another, is often far less significant than the difference that that fund will return to you as a result of fees. If you invest in a fund that charges 20 basis points or 0.2% per year versus 2% per year, the difference in your overall wealth at the end of your investment period, is literally a fortune. Years ago, I did a speech and I was trying to explain why I thought for example, hedge funds were a problem, because they charge such a high fee. The woman I was chatting with told me she had $90,000 invested and she had a 20 year time horizon. I said okay, the difference between the fees you’re paying with this hedge fund versus if you just did an index fund with 1.8% per year. Over time, it’s going to be a 10% return. That’s going to be almost a quarter of a million dollars difference in how much you have at the end of the day. Me personally, I don’t mind paying fees for stuff that is valuable to me, but if an investment manager is going to charge me $250,000 over the course of 20 years, they need to do something more significant than invest my money. They need to watch my children, take out the trash, do the dishes, you know something that I’m going to appreciate a lot more.
JIM: I’ve read the stats. I think it’s only somewhere around 15% of portfolio managers actually beat the index, so it’s important. Not all funds are alike. You need to look at that, and that can have an important impact on the overall performance at the end of the day. One of the biggest fees I think most people ignore, is the fee of taxes. Understanding portfolio turnover, if you have a fund that turns over 400% and another one that maybe turns over 2%, that 400% turnover, could generate a lot of ordinary income taxes. If you’re looking at a 30% tax bracket, or 35 between state and Federal, well, if you’ve got a fund that’s earning 12%, that’s like having a 25% fee. You really got to be careful and look at all the costs that are associated owning a fund, understanding whether or not to take advantage of IRAs. If you have a fund that you like that does a lot of turnover, maybe it needs to be tax sheltered in the form of an IRA or a 401(k), and the funds that you have outside of those types of retirement accounts, you’ve got to be a lot more sensitive to what impact the taxes are going to have. Would you agree with that?
KATHY: Yes. I think you have to look at the total cost of anything that you invest in. Whether it’s a fund, or if you’re buying and selling individual stocks, then taxes are definitely a portion of that, as are just brokerage fees, the investment management fees, all that stuff. Look at that as a whole, and be realistic about the fact that most managers don’t beat the index, so you’re giving that up each year, and the compounding on even a minor difference over many years is a fortune.
JIM: Yes. So let’s wrap up with what is the best strategy to make sure you stick to a plan.
KATHY: You’ve got to make a plan first. The big thing is that a lot of people get started inadvertently. They get a job. It offers a 401(k). They participate, either because they opted in or because their employer has a default option that puts 3% of their income into a 401(k), but they never sat down to think about hey, what are my goals. What am I trying to accomplish with my money, because the biggest thing everybody has to remember is that money is a tool. It’s a tool that is designed to make you calm and comfortable for the rest of your life. So, how do I use this tool for now and for later? That’s up to each individual to sit down, and think about what they want in life. It’s actually the fun part of financial planning. What do I want and when do I want to get that? Now, let’s draw up a plan to make that happen. If you have that plan, and if you understand what you’re investing in to accomplish those goals, it is much easier to be calm through the markets manic depressive phases. It’s much easier to stick with the program, and it’s much easier to give up some of today’s consumerism in order to put money aside for the things that are much more precious, but long term.
JIM: That is well said. I think that is the key. Another key to that is, you should start yesterday, and what I mean by that, is too many people wait until they’re five or 10 years away from retirement because they’re going along with that consumer mentality, and unfortunately, there’s so many advertising that’s hitting us from all different ends; we deserve the new car, we deserve a break today to go through the drive thru at McDonald’s, and we deserve this, and we deserve that, have it now, pay later. Well, you’re really going to pay later if you don’t put away for your future. There is nothing worse than being at a stage of life of the golden years, and there’s no gold.
KATHY: I’d like to have people visualize that when you buy something big that you can’t pay for with cash, you should picture yourself being tied to that product. So take your right hand, and tie it to that car, and take your left hand and tie it to that closet full of shoes, and pretty soon, you realize that you are so constrained by your past purchases, that you can’t move. You can’t change your job if you want to. You can’t do anything else. Now the person who doesn’t tie themselves to all these products, that person is free, and if you want to know what I think people deserve, I think they deserve to be free. I think they deserve to be able to use their money to buy them piece of mind, and that’s what you do when you plan ahead.
JIM: You know, I couldn’t have said it any better. That is just awesome. I think those are words of wisdom, that people can live by and if you haven’t really got serious about your financial plan, hopefully today, you’ve inspired a few of our listeners to take the bull by the horns and get started. Because it’s never too late to start, but the important thing is that you do take those first steps towards your financial security. Thanks Kathy. I really appreciate you joining us. I’m sure you’ve inspired our listeners today.
KATHY: Well, thanks a lot. Have a great day.
JIM: Thanks for joining us this week and tune in again next week, as we explore another phase of the Real Wealth process. Remember, if anything you heard in today’s show, you’d like to get more information about, contact your Real Wealth advisor. Also, if you feel that any of this information will be helpful to a friend or family member, just click the forward to a friend button.