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Protect Your Investment Portfolio:  Avoid Being an Amateur Investor

Posted by kdadmin on November 25th, 2015.

Protect Your Investment Portfolio:  Avoid Being an Amateur Investor

When people discover that I own an investment company, one of the first questions I get is, “How do you protect your investment portfolio?” Well, to be honest, often people have a specific, totally irrational fear (like from global warming or the commies – I’m not kidding). But, generally, all of these concerns stem from a lack of perspective and a fear of volatility. So, I thought I’d write an article about it. We’ll start with recent events.

Over the last five days, the stock market has been like a little yippy dog (see above). Both celebrating (Yay!) and mourning (Boo!) the global news with near schizophrenic (Ahh!!) precision. Whereas the bond market has been calmly plodding along, ignoring the fuss.

How I Was Able To Protect YourInvestment Portfolio Over the Last Six Months.

Six months ago, at the S&P500’s market high, I dumped our entire stock position, explaining my rationale in the article, And We’re Out of Stocks. From that point to now, I’ve held a mixture of bonds and cash. Let’s see how I did …

As you can see from the chart below, this strategy has nicely averted the S&P500’s erratic volatility. SPY (an ETF based on the S&P500) has been up and down, losing more than 11%, twice, and has never regain edits May peak. AGG (an ETF tracking the aggregate bond index) avoided all of that volatility, plodded along, and posted a 0.22% gain. CMR (an ETF tracking money market – aka cash- returns), of course, was essentially flat at 0.14% for the period. If you had to pick two investments for the last six months, which two of these would you have chosen? The same two I chose: BONDS and CASH.

Over the last six months, bonds and cash have outperformed the stock market.

Amateur Investors Lack Accurate Perspective

The primary challenge with investing is accurate perspective. Amateur investors look at the stock market in big lumps of time and generalize its trends. For example, an amateur investor would point out the stock market has outperformed bonds and cash ever since 2009, when taken as a whole period. While that may be true, those same amateurs forget that during that time, the Federal Reserve was stimulating the economy with its various Quantitative Easing (QE) programs. WHICH IT IS NO LONGER IS DOING!

Because amateur investors miss this very essential fact of QE, they then assumes they should always be in stocks instead of bonds and cash. And so, for the last six months, amateur investors who were invested in stocks, instead of bonds and cash, went on a hugely volatile, punishing ride, ending at a loss.

A ride that I, and my clients, avoided.

Amateur Investors Mistakenly Put Their Faith in Celebrity Investors

As if to add insult to injury, amateur investors often latch onto a celebrity business person or investor, project their need for an oracle onto said person, and then try to mimic the oracle’s investment patterns. Whether it be Warren Buffet, Bill Gates, Steve Jobs, Carl Icahn or Elon Musk, amateur investors don’t realize that these people, these heavy hitters of business, technology or investing, employFAR different strategies than the amateur investor. Take Warren Buffet, for example, who often buys entire, or controlling interest, in companies so he can have a direct impact on their operations. This is NOT the same as buying a few hundred shares of the stock like an amateur investor would do.

Or, take Elon Musk’s involvement with Tesla and Solar City over the past two and a half years. (See chart below.) Telsa has had a bumpy ride, sometimes winning or losing by as much as 40% in under six months, to peak out at 150% up in the fall of 2014, and to settle at 105% up today. SolarCity, an entirely different company than Tesla and with a MUCH different market, peaked out in early 2014 at about 77% up, only to slide to a 39% loss. In other words, SolarCity is down 116% in just under two years. With tax credits set to expire at the end of 2016, it’s anybody’s guess if the project can survive without government support. While it is moving its focus overseas, its financial future is far less certain.

Even though Elon Musk contributed $10 million to SolarCity two weeks ago, it’s critical to remember than Elon’s net worth is $13 billion. So, a $10 million investment is about 0.07% of his net worth. In other words, for an investor with a net worth of $1 million, that would only be about a $700 investment.

Tesla and Solar City's stock prices have an inverse relationship to USO (West Texas Crude ETF)

External Factors Matter. Notice how the prices of Tesla and SolarCity were directly affected (as in tracked) the falling price of USO (An ETF that tracks the price of West Texas Intermediate Oil)? Notice how both Tesla and SolarCity increased in value, directly, when USO started to fall to all time lows? Notice how both Tesla and SolarCity increased again when USO then failed to stage a rally recently? So, unless you think Elon Musk was personally able to cut the global oil price in half, he necessarily doesn’t deserve a lot of credit for the gains in the stock prices of the companies he controls.

How to Avoid Being anAmateur Investor

Luck does not work. Neither does imagining that an oracle has your same life objectives or limited resources. Essentially, you have two options.

  1. Hire aFinancial Advisor
  2. Become a Financial Advisor.

Hire a Financial Advisor.

If you don’t want to invest the 10,000 hours it will take to be good in this field, or the 25,000 hours it takes to be great, your best bet is to hire a pro and go spend those hours on something that YOU love. Sure, I’m biased. But, I’ve watched the wreckage created and the damaged caused by amateur investor after amateur investor thinking they found the sure way to make money in the market, when nobody else has.

So much so that I’ve written guide to educate the public about the different types of financial advisors, how they’re compensated, what they charge, what their qualifications could or should be, how they prove that, with which professional organizations or institutions they associate, etc. I want people to have a sense of what is available before they try to build their financial future on a wing and a prayer.

I’ll likely publish a link to it sometime next week. If you’re interested, be sure you’ve subscribed to my blog, and you’ll be notified.

One caveat. I do have some clients who just like to play in the market. They’ll create an account that represents less than 5% of their total net worth and try their luck in the stock market. They see it just this way. Luck. This is fine. It can be fun. It can be horrible. No problem. The three operative words here are: luck, fun, play. These clients are NOT supposing to be able to run their whole portfolio in a way that will likely support their retirement until the day they die. But rather, they are playing with a limited set of securities, with the resources of a professional advisor, the opportunity to bounce ideas of him. In other words, they would be sad if they lost everything in this small account, but it wouldn’t tank their over all financial security.

Become a Financial Advisor.

Hey! Welcome to the family! Sadly, anybody can call themselves a Financial Advisor. But that doesn’t make it so. It’s like how anybody can call a school a Montessori school, but that doesn’t mean they meet the standards set forth by a governing educational body, like Association Montessori Internationale.

Honestly, the process to become a GREAT financial advisor is a tough one. It requires years of schooling, countless hours of face to face client experience, thousands of hours studying an every changing market, and then the courage to not only invest your own money, but to know that hundreds of people rely on you to help them realize their own financial goals. It’s not for the faint of heart. HOWEVER, in order to help you along, I’ve written an article about a financial advisor’s educational requirements that is set to be published in December. Stay tuned.

Pick Your Passion

At the end of the day, you have to pick your passion.

Does being able to Live the Life You Love include spending thousands of hour studying the investment market? If so, become a financial advisor. But if not, if you really don’t want to learn about covariance, or the bond duration, or global economics; but instead would maybe like to paint or travel or sail or read fiction or sing or play your guitar or giggle with your grandchildren or children or ride fat tire mountain bikes or ski or, or, or … Then, quit while you’re ahead.

Give somebody else the reins, and let THEM write blogs about how they were able to Protect Your Investment Portfolio over the last six months

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