Small Gains + Large Risks = Terrible Results

Investors constantly try to grab nickels in front of steamrollers.

Trading dollars for nickels will never make you rich.

Poor risk management goes for other parts of our lives.

A trainer at CrossFit helped prove this hypothesis. Yes, I go there. I don’t mention it much for two reasons:

#1 –  I suck at it.

#2  – I remember getting a Christmas card with a picture of someone doing a clean and jerk on the cover; the “jerk” was actually on the cover.  That scarred me for life.

The trainer was sick for a couple of days. When I asked him where he had been he replied, “I ate some bad turkey and got food poisoning.” (This further confirmed my belief all Thanksgiving food should be banned.)

He continued, “I ate the first piece and it smelled bad and tasted funny.”  And yet, he confessed, it didn’t stop him from eating a total of seven pieces of the foul fowl.

After gathering myself, I countered, “Why did you continue to eat six more pieces if you thought the first one was bad?”

“I was hungry.”

Think of all the projectile vomiting that could have been spared if he waited 15 minutes and ordered a Domino’s pizza. If they are late, your pizza is free.

Instead, my muscular friend decided to pick up a nickel in front of a steamroller and eat the smelly turkey. He got squashed.

Frequently, investors make similar decisions regarding their finances.

Pretentious finance types use jargon like, fat-tailed distribution, kurtosis, or skew to impress the impressionable. Frankly, investors need to focus on risk management in plain English.

Recurrent nickel grabs include:

  1. Chasing yield for extra income – Many investors fail to realize the extra 2-3% in interest is not worth the price. Often people will pick bond funds or other investments because they will get a few extra dollars in their pockets compared to a stodgy C.D. or U.S. Treasuries. They don’t realize this could result in double-digit losses for their “safe” money. The extra interest is often generated by investing in lower grade bonds which can default. Leverage, or borrowed money, can also help juice the yield. In both examples, an economic downturn will devastate the effect of any extra interest collected during better times. Not worth it.
  2. Ignoring life insurance due to its cost – People can be penny wise but pound foolish with their monthly spending. For as little as $50-100 a month, healthy and relatively young people can purchase a decent slug of term life insurance. Instead of making this wise decision, this money will go to Starbucks or something similar.  Reward: You get some good coffee; Risk: You leave your dependents destitute. This decision is right up there with eating the bad turkey.
  3. Avoiding uncomfortable estate planning conversations – We all know deciding who will pull the plug on us is an unpleasant task. Neither is determining what relatives your kids will live with if you meet an untimely death. What’s much worse than this temporary pain is not creating a basic estate plan, which includes a will, healthcare proxy and durable power of attorney. The relief of avoiding a morbid conversation with a lawyer is not worth the price of having the courts determine who your children live with. It won’t compensate for spending years on life support against your wishes. Not having a trusted and competent friend or family member handle your finances if you cannot is something none of us desires.

Investors need to make sure they are compensated for the risks they take.

Some of these include: Investing in global capitalism over long periods of time; spending money to insure against remote, but devastating, financial scenarios; and protecting savings with low-yielding but high-quality investments.

If the turkey smells bad don’t eat it.  Ask my friend. It’s not worth it.

Neither is avoiding uncomfortable decisions about your finances, “saving” money by not purchasing necessary insurance, and picking investments solely based on their yield.

Watch out for steamrollers.

The victims are usually not paying attention.