GMR 93: Is the News a Good Place to Get Investment Advice?
Episode 93
Investing is quite simple. If you go by historical data, and you invest in the stock market consistently over your working life, you will gain a significant amount of wealth. So why don’t more people follow this model of success? In this episode of GMR, we discuss the investor’s risk tolerance and why following the news will not help you to reach your investment goals.
SHOW NOTES
Stock Market is a great way to invest. Buying and holding low-cost mutual funds and index funds can make you wealthy. The Market has returned an average of 11.3 % over an 82-year history.
So if it's so easy, why doesn't everyone do it?
Because we are emotional and often irrational human beings, we have feelings and emotions that sometimes run contrary to logic and statistical data. Humans are the only creature that worries about the future. We are worried and fearful about what we cannot control. Some people are more risk-averse than others. No one likes to lose, especially invested money we depend on to provide for our future when we may not be able to work anymore.
Risk tolerance has a great deal to do with how you invest and how likely you are to reach your investment goals.
What is Risk Tolerance?
Risk tolerance is an investor's ability to psychologically endure the potential of losing money on an investment. A person's risk tolerance can change throughout his/her life and determines what type of investments he/she is likely to make.
High-Risk Tolerance
These investors are aware of the ups & downs of investing in the stock market. They are often labeled as "aggressive," and might be in mutual funds called "aggressive allocation," meaning that they are primarily in stocks instead of bonds or other investments.
They have a deep understanding of stock, and their inclination allows them to purchase highly volatile investments, such as small-company stocks that can plummet to zero.
While maintaining a base of low or no risk investments, high-risk investors reach for maximum returns with maximum risk.
Moderate Risk Tolerance
Moderate investors accept some risk to their principal, but they balance their stock investments with other asset types to soften the hard swings of the market. You'll see people become more moderate as they get closer to retirement or when they have a smaller window of time to invest, like 5 to 10 years.
Combining large-company mutual funds with less volatile bonds, moderate investors often look for a 50/50 mix between stocks and bonds. Or they might focus more on their stock investing in dividend-paying companies that have been around for 20-50 years.
Low-Risk Tolerance
Low-risk investors are willing to accept little to no volatility in their investment portfolios.
Often, retirees who have spent decades building a nest egg are unwilling to allow any risk to their principal.
A low-risk investor targets vehicles that are guaranteed and highly liquid.
Risk-averse individuals opt for bank certificates of deposit (CD's), money markets, annuities, or U.S. Treasuries for the preservation of their capital, along with minimal gains.
How the News Influences Your Investing Decisions and How to Stay on Your Investment Path
For the twenty years ending 12/31/2015, the S&P 500 Index averaged 9.85% a year. A pretty attractive historical return. Why then did the average equity fund investor earn a market return of only 5.19%.
The reasons for low investor returns
Investor behavior is illogical and often based on emotion.
Emotional behavior does not lead to wise long-term investing decisions.
Many investors see the news and see the stock market going up; they get excited and start buying stocks when they are the most expensive.
When it goes down, they pull money out.
Irrational behavior causes investor market returns to be substantially less than historical stock market returns
What would cause investors to exhibit such poor judgment? After all, at a 9% return, your money will double every eight years.
Rather than chasing performance, you could have bought a single index fund, and earned significantly higher yields.
An advisor can serve as an intermediary between you and your emotions.
If you are going to manage your own investments, you'll need a way to keep your emotions out of the buy/sell process. Consider using the four tips below to make smarter decisions:
Do nothing. A conscious and thoughtful decision to do nothing is still a form of action. Have your financial goals changed? If your portfolio is built around your long-term goals (as it should be), a short-term change in markets shouldn't matter.
Your money is like a bar of soap. To quote Gene Fama Jr., a famed economist, "Your money is like a bar of soap. The more you handle it, the less you'll have."
Never sell equities in a down market. If your funds are allocated correctly, you should never need to sell equities during a down market cycle. This holds true even if you are taking income. Just as you wouldn't run out and put a for sale sign on your home when the housing market turns south, don't be rash to sell equities when the stock market goes through a bear market cycle. Wait it out.
Science works. It's been academically proven that a disciplined approach to investing delivers higher market returns. Yeah, it's boring; but it works. If you don't have discipline, you probably shouldn't be managing your investments.
There's a reason "if it bleeds it leads" is a cliché. The media know that scary stories bypass some of our critical filters and have enormous staying power for evolutionary reasons.
Recession News
2015 - The U.S. could go into recession in 2015: Expert Opinion
Plunging oil prices
2016 - Will the U.S. economy slip into recession in 2016?
Emerging economies are struggling
2017 - There's more than 60% chance of a global recession within the next 18 months, economist says
High International Borrowing Levels
Global Inflation
2018 - Recession: 6 signs we're closer to the next recession than you think
The unemployment rate is too good
The yield curve is flattening
Inflation is growing
Home sales slowing
Too long of a bull market
2019 - The U.S. Is Likely Headed for a 'Semi-Recession
The decline in industrial production
Slowing in manufacturing
Sources: CNBC, Washington Post, CBS, USA Today
I don't know of any great investors who attribute their success in investing to following the news or daily headlines. If you know anyone who watches the news and uses headlines to buy stocks and has found great success, I'd be shocked. Send me their name, and I'll interview them. The news is not going to bring you wealth.
““Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their ‘chart’ patterns, the ‘target’ prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be), our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally, the cash register will ring loudly. And sometimes I will make expensive mistakes. Overall – and over time – we should get decent results. In America, equity investors have the wind at their back.””
RESOURCES
Budgeting and Debt Elimination Tools
Jesus on Money by David Thompson - stewardshippastors.com