Some things might kill you instantly like a dagger through the heart. Others might ravage your body over a prolonged period of time, like a chronic disease.
Investing follows these same principles. Unfortunately, a slow or quick death is often the result for many portfolios. There are many immediate portfolio killers but often what investors do not fear are the most lethal assassins.
We can categorize investor’s sometimes misplaced fears into three categories: Scary, but not dangerous; dangerous, but not scary; and, the perfect financial storm, dangerous and scary.
Here are some descriptions and examples of common investing misconceptions:
Scary, but not Dangerous
- Market Corrections: They can be terrifying in the short term. Corrections, defined as a 10% market decline, are quite common. According to Marquette Associates, since 1950, 56% of the following years experienced at least one 10% draw-down. Like a bad case of food poisoning, these experiences are sudden and violent. Just like these horrific bodily functions, the long-term effects are minimal. In fact, these corrections are tremendous buying opportunities for those with diversified portfolios and a long-term outlook.
- Bear Markets: Much more hair-raising than the dreaded correction, these very unpleasant experiences are categorized by market drops of at least 20% from previous peaks. According to Putnam Investments, bear markets have taken place 13 times over the last 66 years. They have lasted an average of 14 months and had an average decline of 24.6%. Though unnerving, they are a normal part of the business cycle. Without these drops, markets could not go up and, therefore, are the reason stocks are the best returning asset class over long periods of time. These plunges have been more than offset by the reemerging bull market that follows the storm. These upswings typically last about 44 months and come with an average return of about 117%. For the long-term investor, these cliff dives are a blessing, rather than a scary night mare.
Dangerous, but not Scary
- Deficient Estate Planning: These documents are not hyped by the financial media. They are also not on the immediate investor time horizon. Do not kid yourself. Not having a properly drafted will, health care proxy, or durable power of attorney are far more terrifying than a common market hiccup. Neglecting these items can create unbounded terror for your heirs.
- Ignoring Retirement Plans: These plans are very easy to ignore, but dangerous beyond words. There is nothing more detrimental to a retirement plan than turning a blind eye to the miracle of compound interest. Not contributing to a 401(k )or 403(b) account may give you the temporary safe sanctuary of excess cash flow. This respite is misleading because winter will soon be coming for your retirement account. You will realize those extra Starbucks frappachinos you were able to buy because of your non contributions were much more expensive than the sticker price.
- Being Underinsured: Not having enough disability or life insurance will have little effect on your safe daily activities. This will all change when the inevitable unexpected occurs. Health and mortality are often thought of as entitlements. Nothing could be further from the truth. Not having an extra bill to pay may give you an illusion of security. This mirage will eventually turn into a barren desert of financial hell if and when the unexpected rears its ugly head.
Dangerous and Scary
- Emotional investing: Listening to Gold Bugs, political investors and financial prophets of doom will not only scare you but also devastate your investment portfolio. Ignore evidence-based investing at your peril. Charlatans will make themselves rich from your misfortune.
- Employing a High Pressure Financial Salesperson as your Advisor– Not only will these people frighten but you will end up with a high cost ineffective investment product. Only bad products pay high commissions. Common sense tells you this. Perverse sales incentives are designed to prey on your fears and pay the seller handsomely. Do not ever forget this.
- Using Leverage with a Concentrated Portfolio: Nothing is scarier than knowing you could actually lose more than you originally invested. This can happen with borrowing money to purchase a stock; not diversifying only compounds this problem. Never, under any circumstances, should you do this.
The famed investor William Bernstein calls this deep versus shallow risk. The deep version refers to the fact that you could permanently lose your capital. The shallow version properly describes the temporary losses the inevitable corrections and bear markets will bring.
Save yourself from these misconceptions by hiring an advisor who will educate you rather than sell you products. Having a good behavioral counselor is worth his/her weight in gold. Finding a fee-only, non-conflicted, evidence based investment philosophy following advisor that focuses on client goals is a good start. There is nothing scary about this. Create your own category of “not scary, and not dangerous”. This is a far better option.