Tag: Investing

Many of us either fish, or know someone who fishes, and the tendency to focus on the “big one” or “the one that got away”.

There is something inherently natural about valuing ourselves for our biggest catch. Perhaps it boils down to a primal need to feed ourselves and our families — and the bigger the catch, the more we eat.

It’s not the size that matters

But, as I’m sure any honest fisherman will tell you, big catches happen very infrequently. Meaning if you rely on the “big fish” to eat, you may end up going hungry.

The better way to measure your success is the overall number of the fish you bring in the boat.

The more fish you reel in, and the more frequently you do so, the more likely you are to feed your family. And the best way to increase your chances of a catch?

Put more hooks in the water.

Increasing the odds

Having multiple hooks means you can use various baits and hook sizes, optimizing your chances of bringing in all types of fish.

This principle holds true for investors as well. We seem to overvalue the big wins and undervalue the end-goal of enhancing our long-term return.

We focus on the individual holdings that do really well (or poorly) but rarely take the time to think about how each individual holding affects the portfolio as a whole.

We focus so hard getting one big win, that we don’t take the time to bait the other hooks.

While baiting multiple hooks (creating a diversified portfolio) doesn’t guarantee a catch on all of them, it does increase the chances that you won’t walk away empty-handed.

And this is the single most important aspect of this analogy. While a diversified portfolio may not increase by 100% in a year, it also curtails the possibility of a dramatic decrease as well.

Meaning, you will be more likely to have steady returns that “feed” your portfolio continually each year.

conditions change

As an extra note, you’ll also have to account for the fact that water conditions change.

Not everything that works in one season will work in another.

Market trends and the economy are a lot like water conditions, they are always changing. It would be foolish to suggest a fisherman bait his hook and leave it in the water forever.

Most likely that bait will lose its appeal to the fish and won’t catch anything.

It is best practice to reel in your hook, check the bait, and change it out if it isn’t working.

FOMO (fear of missing out). I’m sure you’ve felt it before while being bombarded with headline after headline about everyday people striking it big with relatively little investment in the latest investment fad.

Take this one for example, “Idaho teenager becomes a millionaire overnight by investing $1,000 in Bitcoin” It’s so easy a teenager can do it!

Before you know it, you’re sucked into the hype and putting money into something you barely understand.

But whether it’s cryptocurrencies, cannabis stocks, or whatever fad is the topic of conversation right now how do you determine if you should really be jumping on the bandwagon?

Investing versus Speculating

You need to understand the difference between investing and speculating.

An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. 

Benjamin Graham, The Intelligent Investor

One of the worst mistakes someone can make is speculating with their money when they think they are investing.

The only way you can consider yourself an investor is if you develop strict investment guidelines to follow and actually understand the company you are investing in. Without that, you’re just relying on luck.

Keep Your Lizard Brain At Bay

Another thing you’ll want to be aware of is that primitive part of your brain that functions purely off of emotion. 

Our brains are hard-wired for thrill-seeking. Think about rollercoasters, haunted houses, gambling, and speculative investing. They all cause our bodies to release dopamine throughout our system which makes us feel good. 

It’s this part of your brain that is going to make it difficult to follow any investment guidelines you’ve put in place. 

Timing Is Everything

Even if you’re the next wunderkind of investing, it won’t matter much if you’re late to the game. Just look at what happened with Bitcoin a few years ago.

Early adopters — the ones who rode the wave as euphoria grew and knew when to get out — were the ones who came out on top.

Speculators who bought near or at the peak, hoping that the rise would continue, were caught with their pants down as the value plunged seemingly overnight.

Is It Right For You?

The idea of striking it big with just a little bit of money and effort is appealing. Just like winning the lottery.

But unless you on track with your financial goals, and have the disposable income to play with, I recommend focusing your efforts on the only true way to build wealth which is saving!

A byproduct of being a financial advisor is the random financial advice texts from friends and family. One of the most common by far is, “What should I pick in my 401k?”.

While I try to be as helpful as possible, I can usually only answer with, “It depends…”.

Without knowing the fund offerings of the 401k plan, your investments outside of the 401k, your goals, and your risk tolerance, there is practically no way to say which investment options to choose.

Having said that, there are general tips that anyone can apply when making decisions related to a 401k.

Before we get to that though, I think it’s important to understand the basics of investing.

Back to the Basics

There are three basic choices when it comes to investing:

• Cash or investments that can be turned into cash quickly. Sometimes also called capital preservation.

• Bonds, which is essentially you loaning money to a government or corporation in return for a fixed payment back.

• Stocks, which is a share of ownership in a corporation.

Historically, capital preservation and bonds are less risky than stocks but have a lower potential for return.

You’ll probably notice there aren’t any individual bonds or stocks listed as investment options in your fund line up. That’s because it’s hard for the average investor to purchase enough individual stocks and bonds to create a portfolio that is varied enough. So instead, you have a variety of mutual funds or exchange-traded funds (ETFs) to choose from.

Mutual Funds and ETFs. What are those?

Both mutual funds and ETFs are pools of money that are managed by a professional money manager and have a stated objective, such as investing in only Large U.S. tech companies or tracking an index.

The biggest advantage of mutual funds and ETFs is the instant diversification it can give you. That’s because the money manager is able to pool your money with thousands of other investors and purchase a mix of individual stocks and bonds that you wouldn’t have been able to otherwise.

Diversifying helps reduce your overall risk. Think about what your parents used to tell you, “don’t put all of your eggs in one basket!”. With mutual funds and ETFs, you are spreading your money across enough investments to reduce the risk of being wiped out by a single bad bet.

Just because you diversify doesn’t mean you don’t run the risk of losing money. The markets fluctuate up and down, and sometimes, they come down a lot. But that’s okay because contributions will be going into the account on a regular basis.

Having money going into your account every month enables you to build significant wealth. That’s because if the price of the investment drops, you are buying it at a discount. We all like buying things at discounts!

so… What Should I Choose?

Luckily, a majority of the hard work has already been done for you. Through a rigorous screening process, an investment fiduciary has pre-selected which mutual funds and ETFs are available to choose from. This is commonly known as the fund lineup.

TIP 1: Everyone is different when it comes to how they want to invest their retirement plan account, and before you make any decisions, I recommend filling out a risk profile questionnaire. This will give you an idea of what type of asset allocation fits your proximity to retirement and your willingness/ability to take risks.

Asset Allocation Matters

Asset allocation simply explains the mix of stocks, bonds, and cash in which you decide to invest. Broadly speaking, the younger you are the larger the share of stocks you should have in your 401k. As you approach retirement there should be a more balanced mix between stocks and bonds as you switch from solely focusing on growing your money to also caring about preserving it.

It’s common to see funds within your 401k plan that basically use autopilot to shift your asset allocation from stocks to bonds as you get older. These are known as Target Date Funds (lifecycle, target retirement) and you’ll usually see a naming convention like Target Date 2045. The year being your goal retirement date.

TIP 2: A mistake I often see is someone choosing a target-date fund but then also having other mutual funds selected that are being invested in the same manner. This means they are doubling their exposure to that asset class and paying twice the fees for no benefit at all! Stick with either a mix of stock and bond mutual funds that meet your asset allocation goals or go with a corresponding target-date fund, but not both.

keep fees in mind

TIP 3: No matter what investment options you go with, always keep fees in mind. They are usually referred to as the “expense ratio”.

The fees on the various funds can vary significantly too. According to the Investment Company Institute, in 2019, the average expense ratio of actively managed equity mutual funds was 0.74% compared to passive stock mutual fund expense ratios of 0.07%. This means that the bill on the $100,000 invested in your 401k could be $740 or $7 a year. Assuming 5% growth per year on that $100,000 for the next 20 years – the 0.74% fund would have a cost of $33,500.

There are very few factors under your control when it comes to future investment results, but one that you do control are the fees you pay.

If you work for a large corporation, chances are they offer some way to obtain company stock. A lot of companies use stock (ownership in the company) as a compensation incentive and as a retention tool for key employees.

various Ways to obtain employer stock

There are numerous ways that your employer can make their stock accessible to you. Here are the most common ways that I see:

1. Stock Options (ISOs and NSOs)
2. Restricted Stock
3. Restricted Stock Units (RSUs)
4. Stock Appreciation Rights (SARs)
5. Phantom Stock
6. Employee Stock Purchase Plans
7. Employee Stock Ownership Plans
8. As one of the investment option of your defined contribution plan

Talk about complex!

No matter which way they present it though, the end result is usually the same. You take them up on their offer and you accumulate more and more company stock as time goes on.

And, why not? You’ve been there for years, you love what you do, and you can’t imagine the company ever going out of business.

the Rewards

Do you want to know a potential way of getting rich? Putting a sizable percentage of your portfolio in one asset that appreciates in value.

Imagine working for Google or Facebook over the past several years and acquiring company stock along the way. You could have accumulated quite a bit of money by taking part in one of their employee stock purchase plans.

It’s rare circumstances like these that having the majority of your portfolio consist of your employer’s stock can pay off.

The risks

Do you want to know a potential way to lose all your money? Putting a sizable percentage of your portfolio in one asset that depreciates in value.

Take General Electric (GE) for example. GE is one of the most recognizable companies in the world. I bet the employees of General Electric never thought twice about owning its stock.

But it’s share price has fallen nearly 80% since March of 2016. This kind of price decline would be absolutely devastating to an employee with a majority of their retirement savings in the company stock.

double the risk, double the pain

No matter what your view on the financial stability of your employer is, the simple fact is that employer stock is one of the riskiest investments you can own.

By simply by working for your employer, you already have a large portion of your personal financial success tied to your employer’s success.

Your job provides you income, which enables you to save for the future in the first place. Your financial wellbeing is already dependent on your employer, adding company stock into the mix only doubles your risk. If your employer goes out of business, you lose your job and your retirement security.

How Much is too much?

Okay. You’re probably at the point where you want to sell all of your company stock. But that’s not the message I want to convey.

It’s true that I think the risk of having too much employer stock in your portfolio outweighs the potential rewards but a small portion can be part of a generally diversified portfolio.

A general rule of thumb to follow is to have no more than 5% of your investment portfolio in any single stock (not just your employer’s).

Of course, the thing about rules of thumb is that not everyone’s thumb is the same.

In order to determine if you have too much company stock in your portfolio, consider these four things:

1. What is your appetite for risk? If you are the gambling type and can stomach the thought of your investment losing value if it means hitting the big one, then a higher allocation to a single stock might make sense for you.
2. Do you have the ability to take the risk? If the stock drops in value by even 40%, will it totally disrupt your ability to retire? If you have sizable, diversified, retirement savings outside of your employer stock you can probably take on more risk than if you didn’t.
3. How many years until you retire? If you are 20 to 30 years away from retirement, you have the time to make up for loses and can be a little more concentrated. If you are within 20 years of retirement, you’ll probably want to scale back.
4. Does the stock fit into your overall financial plan? Will the stock help you achieve the rate of return you need to reach your retirement goal? There might be a specific purpose for the employer stock and it’s okay to be a little more concentrated.

At the end of the day, it takes having a well thought out financial plan to determine how you handle your concentrated stock positions, so make sure you have one!