Why Investment Failures Are So Important

investment failures

A Princeton professor has made waves online by publishing his own resume of failures — grants he did not get, schools that turned him down. He’s not the first academic to do so, as he notes, but it’s an interesting exercise nonetheless.

The professor, Johannes Haushofer, took on this masochist effort not to punish himself but, as he put it, to give some perspective on his successes.

“Most of what I try fails, but these failures are often invisible, while the successes are visible. I have noticed that this sometimes gives others the impression that most things work out for me,” he wrote.

investment failures

It’s instructive to think about his approach to failure in terms of retirement investing. A lot of people think that the best approach is to buy a small number of investments and never sell.

Others take the view that you should try lots of things, getting in and out of the market often. After all, why spend months or years on investment failures when so many clear winners are out there to buy?

It’s counterintuitive, but you should do both: It’s important to buy investments and hold them for long periods and to avoid trading. But it’s also important to try to own the best-performing investments.

How do you know which are which? Here’s the beauty: You don’t have to know anything at all.

Portfolio investing is about owning asset classes, not individual stocks or bonds. Index funds allow investors to buy and hold whole markets. Since the funds rebalance automatically by market cap, you don’t have to worry about buying and selling.

Likewise, you don’t have to try to guess which asset class is going to do better or worse in the coming months or years. Rather, you just to be sure to own an appropriate amount of each investment type, be it stocks, bonds, real estate or commodities.

Over time, one investment class or another will surge ahead and be an obvious winner. When you go to rebalance, you end up taking those gains while they exist. The resulting cash is available to buy other investments that are down, relatively speaking.

That’s selling high to buy low, which is exactly how you should invest for long-term retirement planning.

Risky decisions

If you do it right, the long-term effect is to diminish the impact of your “failures” in comparison to your “successes.” In fact, the portfolio indexing strategy turns those relative failures into real successes over time.

More importantly, this approach erases the huge emotional risk entailed in focusing on individual investment failures. It also takes your attention off of relative successes, which can be important, too. You get to worry less.

And one more unseen risk: Nothing is worse for a long-term investment plan than a string of accidental “wins” early on in the process. It can give the young investor the impression of knowledge in a business that relies far more on chance, and that can lead to terribly risky decisions in the future.

Ignore Stock Market ‘Round Number’ Days

round number

The Dow Jones Industrial Average just surpassed 18,000 points, overcoming a hurdle of sorts. The market hasn’t hit that specific round number since last summer.

There was no shortage of commentary on the Internet on the big 18K number. And why not? It’s interesting, and that’s what news organizations are about, filling up airtime and empty web pages with mildly interesting facts between bouts of actual news.

round number

 

Should you care? Absolutely not, for a number of reasons:

1. It’s a fallacy to attach importance to round numbers. The Year 2000 came and went and we all got worked up over a supposed global computer shutdown. Remember that?

2. We pass interesting milestones all the time. Dividend yields rise and fall. Inflation consumes more or less of our total return. There are a lot of moving parts here that aren’t being taking into account.

3. Did you feel any different at 30? How about turning 40 or 50? Neither does anybody else.

4. Most importantly, number watching tends to lead to market-timing trades. And those can be truly dangerous.

Do you know for a fact that passing 18,000 on the Dow means we’ll hit 19,000 by year end? You can probably find “evidence” to back up that assertion, if you look for it.

Do you know for fact that passing 18,000 — or 17,000, or any round number — means we’ll soon see a major collapse in stocks back to some previous low, or even lower? Look for it, and you’ll find evidence to support this viewpoint too.

And that’s the problem. Both the round-number optimists and round-number pessimists are guessing. Just guessing.

There is some data somewhere to show either and both outcomes are possible. But there is no data anywhere that proves either outcome is guaranteed.

But let’s step back and just think about optimists vs. pessimists. It’s contrarian to say this, but at least some investors should see rising stock prices as bad news.

Young people, for instance, need a stock market that is tethered to reality. If the price of “getting in” to the stock market goes too high, their risk of a lower long-term return goes up.

Round number reality

An older person, of course, wants stocks to rise and never return to earth. Irrationally high stock prices mean they are richer, at least on paper.

Stock markets are, as Warren Buffett often points out, a voting machine in the short term and a weighing machine in the long term. That is, prices can be wrong, even very wrong, for a while.

But in time they correct to a realistic level and then usually build higher from there. Does it matter that we must passed a round number with a lot of zeroes after it? For the retirement investor serious about building a portfolio, not at all.

What matters is owning stocks consistently, rebalancing periodically and adjusting that portfolio to avoid unnecessary risk as you get age. Round numbers in the stock market are a distraction, a passing headline — and nothing more.

Take An Easy Financial Fitness Quiz

financial fitness

You sweat the extra pounds, eat around the calorie-filled holidays, even time your steps with a newfangled fitness watch. But are you financially fit?

Your financial fitness is not as simple as having an extra few hundred bucks in your checking account and all your bills paid up. That’s a great place to be at 20 years of age, but not at 30 or 40.

financial fitness

Take this easy financial fitness quiz and see if your money life is on track. (Hint: In every case, “C” is the wrong answer):

1. Do you have a 401(k), IRA or other tax-deferred plan through your work?

A. Yep, and it’s funded to the max!

B. I opened it, but I just put in a little, whatever the default is.

C. I might have missed that meeting with human resources.

2. Do you have enough money in the bank right now to pay your bills for the month?

A. Easily, plus the next four to five months if I stretch a little.

B. Maybe? I’d have to check, but I’m confident no bills will go unpaid.

C. I probably don’t have enough cash to buy food for the next week. But I have a credit card, so no problem!

3. Speaking of credit cards…is your credit rating good, bad or ugly?

A. I have “good” or “excellent” credit, no late payments ever and check my credit report at least annually.

B. I’m working on my creditworthiness, but it has been a struggle in the past. I should check it more often, I suppose.

C. Next question, please.

4. If I had a surprise medical cost or other financial emergency tomorrow, I would pay for it by:

A. Dipping into savings with room to spare.

B. Some savings, but maybe borrowing against my home.

C. Hitting up friends and family, maybe letting the bills ride in the meantime.

5. My idea of “enough” for retirement looks like:

A. Social Security plus income from my retirement savings prudently invested for the long run to produce income that matches my realistic cost of living.

B. I plan to work past 65, but mostly that’s to make sure my plan will work out.

C. I will not retire. I have made my peace with that fact.

6. If something happened to me tomorrow, my loved ones can expect:

A. To receive an insurance check that should make up for a decade or more of my lost income.

B. Burial coverage through my work and whatever Social Security will pay out to them.

C. To have to hire a CPA to untangle my accounts and help them figure out how much debt they’re in.

7. My idea of the purpose of money is:

A. Freedom from stress and worry. Truly a means to an end, not just means in the financial sense.

B. To pay for things, since things are the most reasonable measure of wealth.

C. I’ve never thought about it. Money doesn’t stick around long enough for me to have an opinion.

If it isn’t obvious yet, the better choices here are “A” down the board. If you find yourself split between “A” and “B” on your responses, focus on the weak spots and build up your knowledge.

If you’re a solid “C,” time to get cracking and perhaps hire a financial planner to help.

Retirement: Is Your Glass Half-Full?

rich

One of the fundamental premises of retirement saving is prudent compounding. Now, before your eyes glaze over completely, consider two perspectives:

Glass half-full? Half-empty? Which person is doing “better” at saving for retirement?

rich

It’s a trick question: They’re in essentially the same place. Yes, Blake has more money. He also probably makes more and saves about twice what Sally is saving.

But Sally has something Blake does not have and cannot make more of. She has time. And that’s the point about prudent compounding.

Money properly invested will double in value within a certain number of years. Most advisors and planners think of 10% growth as a typical year for the stock market.

Yet they know that most investors cannot stomach the ups and downs of a 100% stock-only portfolio. So, they leaven the mix with bonds and other investments that grow more slowly but do so more surely.

How fast will your money compound? Finance folks like to talk about the Rule of 72, which states that if you know the interest rate and divide it into 72, you can solve for the number of years it takes money to double.

If you think 10% is a reasonable assumption, then you take 72/10 and get 7.2 years to double your money.

Likewise, if you assume something closer to the return on a bond portfolio, around 4%, then the equation becomes 72/4 and you get 18. It will take 18 years for your money to double at that rate of return.

Sally is better off in a mostly stock portfolio. She has more time for money to compound and can likely ignore a sharp decline or two over the decades.

Blake is in a tougher spot. He needs his money to grow but likely cannot handle a major downturn. His emotions might get the better of him.

Prudence and risk

That’s the prudent part. What is the right mix of investments for the goal you seek to achieve, considering how you might react to straying off course? That mix is what is “prudent” for you.

Prudent investing for retirement is about doubling your money as quickly as possible while not taking on risks you cannot accept. Then, once the money has doubled, doubling it again and again.

After a certain point, your idea of what risk means will change. The larger the balance, the more likely you are to seek less-volatile investments. And that’s fine, so long as you make it to your goals and retire in the manner you expect.

Saving For Retirement: Is Your Glass Half Full?

One of the fundamental premises of retirement saving is prudent compounding. Now, before your eyes glaze over completely, consider two perspectives:

Glass half-full? Half-empty? Which person is doing “better” at saving for retirement?

It’s a trick question: They’re in essentially the same place. Yes, Blake has more money. He also probably makes more and saves about twice what Sally is saving.

But Sally has something Blake does not have and cannot make more of. She has time. And that’s the point about prudent compounding.

Money properly invested will double in value within a certain number of years. Most advisors and planners think of 10% growth as a typical year for the stock market.

Yet they know that most investors cannot stomach the ups and downs of a 100% stock-only portfolio. So, they leaven the mix with bonds and other investments that grow more slowly but do so more surely.

How fast will your money compound? Finance folks like to talk about the Rule of 72, which states that if you know the interest rate and divide it into 72, you can solve for the number of years it takes money to double.

If you think 10% is a reasonable assumption, then you take 72/10 and get 7.2 years to double your money.

Likewise, if you assume something closer to the return on a bond portfolio, around 4%, then the equation becomes 72/4 and you get 18. It will take 18 years for your money to double at that rate of return.

Sally is better off in a mostly stock portfolio. She has more time for money to compound and can likely ignore a sharp decline or two over the decades.

Blake is in a tougher spot. He needs his money to grow but likely cannot handle a major downturn. His emotions might get the better of him.

Prudence and risk

That’s the prudent part. What is the right mix of investments for the goal you seek to achieve, considering how you might react to straying off course? That mix is what is “prudent” for you.

Prudent investing for retirement is about doubling your money as quickly as possible while not taking on risks you cannot accept. Then, once the money has doubled, doubling it again and again.

After a certain point, your idea of what risk means will change. The larger the balance, the more likely you are to seek less-volatile investments. And that’s fine, so long as you make it to your goals and retire in the manner you expect.

Investing Basics: What Is Inflation?

what is inflation

Inflation, a good thing or a bad thing? The answer, strangely enough, is “both” and how you react to inflation can deeply affect your retirement investment planning.

First of all, what is inflation? Inflation is nothing more than rising prices. We all know intuitively that things will cost more in the future. The price of energy and food goes up and down pretty quickly, but the average price for most things steadily rises over time.

How fast is the issue. Economists want “healthy” inflation of about 2% and generally accept long-term inflation of perhaps 3%.

what is inflation

Slowly but steadily rising prices are a sign of a growing economy. It signals demand for goods and services that slightly exceeds the available supply.

Over time, demand can slip. When it falls consistently, we tend to worry that a recession has begun, that the economy itself is shrinking.

The opposite can happen, too. Demand can outpace supply dramatically, causing prices to rise more quickly than expected.

The Federal Reserve has tools at its disposal to tamp down inflation or, as in recent years, attempt to keep inflation rising even if the economy is weak. For the retirement investor, these short-run moves by the Fed aren’t important.

What matters is finding investments that provide a return that exceeds inflation over many years. The return you get from the stock market might be 9%, but subtract 3% inflation and your actual purchasing power is growing by 6%.

That’s called “real return,” and it’s the goal of retirement investors to keep that number positive. Your money is likely to double in value — that is, to compound — so long as the real return is high enough. A long run of below-par investment returns isn’t a help if inflation is eating the value of that money along the way, too.

What is inflation risk?

When financial advisors talk about risk, one of the factors that they include is inflation risk, put simply the risk that inflation will grow faster than your expected investment returns. In that scenario your savings actually lose value, despite being invested.

Investors offset inflation risk by making sure that their portfolios include a healthy dollop of growth investments, such as common stocks. While stocks are more volatile than bonds or real estate, they do tend to grow faster than inflation over the years.

A retirement portfolio balances the risk of loss from stock investing against the equally complex risk of purchasing-power loss due to inflation. Keep both risks in check is the job of a well-designed portfolio.

Diversification and rebalancing are the final pieces of the puzzle. Inflation is inevitable and, to a degree, desirable for the economy at large. Just don’t let it become an unacceptable risk to your long-term retirement planning.

When To Use ETFs, When To Avoid Them

when to use etfs

Exchange-traded funds (ETFs) get a strangely bad rap in the investment press. They’re either too risky or too boring, too opaque or too obvious.

Which should lead you to a simple enough conclusion: In most cases and for most investors, they are just right. That’s because a broadly diversified ETF simply reflects the market index it tracks.

You could go out and buy all 500 stocks in the S&P 500, but why? You could pay an active fund manager an exorbitant feet to replicate the stock market, but why?

when to use etfs

Why indeed, if an ETF gives you the reliable exposure you want at a very low price. Nevertheless, when to use ETFs is a reasonable question, as is when to avoid them.

The simple answer is: Use ETFs to own an asset class, such as stocks, bonds, foreign equities, real estate or commodities.

If you know you want a piece of that market but you don’t know which stocks to buy, don’t try to figure it out. Just own the ETF and you own the whole market.

The thing is, study after study has shown that actively managed funds simply can’t keep up with their indexes. Trading tactics go in an out of fashion.

Sometimes managers make brilliant strategic moves and clean up relative the whole market. And sometimes they just blow up.

What follows next is the quiet closing of that fund, then the company that offered it just moves whatever is left of investors’ cash into a similar fund in the same family.

Both the out-sized win and the horrific mistake should seen for what they are — random chance. The manager who “guesses right” on the movement of the market is still guessing.

Funny thing is, he gets paid right or wrong. If actively managed funds had to survive on a percentage of their performance above the benchmark, most would go out of business in no time.

Eventually, even the “winners” would slip up, and all that would be left would be the indexes. That’s why so many billions of retirement dollars are moving steadily toward passive investment portfolios, often using ETFs.

When to use ETFs

When should you avoid ETFs? When an ETF doesn’t do the one simple thing they do well, which is track a major index at a low cost.

You can find ETFs out there that do — or at least claim to do — just about anything. Double the inverse of the price of oil. Twice the performance of the dollar against foreign currencies. Frontier-stock ETFs that track nascent economies such as Mongolia.

In short, if you wouldn’t put your money into given investment as a single stock, the ETF version of that idea is not “more safe” by virtue of being an ETF. Some of these ideas might work out, but most will collapse under their own weight.

When to use ETFs is when you understand the investment and its history very well, you know the track record of the company offering the fund, and you have money to invest for long periods of time — then and only then, an ETF is a great retirement tool.

Should You Worry About Higher Interest Rates?

worry about higher interest rates

Everyone seems to know that interest rates will move higher at some point. But nobody seems to know when.

The first argument — that interest rates will go up — is an easy one to make. The U.S. Federal Reserve has been holding rates down for a very long time.

Mostly, this feat has been achieved using highly artificial means. There’s just no way that’s sustainable and, over time, even extraordinary measures will cease to work.

Yet they can work for a while longer and they have worked for much longer than many pundits had assumed. So the second point, that nobody knows when they will rise, is valid as well.

Federal_Reserve

Should you worry about higher interest rates? As a long-term saver and investor, no, you should not. As a borrower, absolutely yes, you should.

A saver benefits from higher interest rates. First of all, rising interest rates mean that the income from government-issued bonds rise, too. Long-dated Treasury bonds have paid much less than in decades past, and that’s what is in most people’s retirement plans.

Bank account savers will benefit as well. The interest paid on savings accounts and certificates of deposit will go up as the interest rate environment improves.

A rising interest rate doesn’t bode as well for corporations and their stock valuations, since the cost of money is part of their cost of doing business. Nevertheless, if the rise is gradual and predictable — generally the Fed’s preferred way of doing business — the impact on stocks will be minimal.

The only “shock” to the investment world would be a rapid rise in interest rates. That could cause a bond market selloff and force companies to rapidly reorganize finances.

The Fed will do whatever it takes to avoid such a shock, of course. But there are no guarantees they will be successful. Investing implies risk, as always.

Meanwhile, if you are a borrower, a rising interest rate is a different matter altogether. The cost of financing a house will go up, as well as the cost of buying a new car.

All debt is linked to the prime lending rate, which is linked in turn to the general interest rate. A rising floor means a rising ceiling for all revolving and variable debts, such as credit cards, store cards, variable-rate mortgage loans and consumer loans.

Lowering risk

Overall, the best strategy for retirement savers is to be on the right side of the interest rate equation, benefiting from better rates on savings and investments and avoiding the penalty of higher cost debt.

If you have outstanding debts, consider refinancing to a fixed rate or using low-cost home equity to pay down debts. That’s assuming, of course, that you don’t take on new debt soon after.

Likewise, review your retirement investments and find ways to shorten any bond positions you might have that are very long. Consider building a bond ladder or investing in a diversified bond ETF that manages bond market risk for you.

Rising interest rates are not the end of the world — if you are smart about why you borrow and how you invest for the long term.

How To Buy More When Stocks Go On Sale

stocks go on sale

Buy low, sell high. It’s the most logical, common-sense way to invest, right? If only it were so easy.

The problem is, our brains are not built to do the logical thing when it comes to money. We are hardwired by millions of years of biology to avoid risk.

stocks go on sale

We think we know what risk looks like and our brains help us stay away. Dark and rainy night? Take cover. Shifting sense of balance? Crouch down. Any kind of uncertainty about the terrain ahead? Move slow.

Now consider the first three months of this year. A lot of people — far too many of us — took the turn of the new year as a signal to review their investments.

Why? What’s different about January 1 vs. July 1 or October 1 or any other first day of a month? Nothing really, but we look anyway.

From that vantage point, the past several years in the stock market can look like a long climb uphill. We have no credible idea of what’s next, more climbing or a cliff’s edge, but looking backward gives one the sensation of hitting some kind of peak.

Then the reflexes tend to take over. Sure enough, a big sell-off in the market started.

Any trend can end, of course. The S&P 500 is close to back where we started the year, within spitting distance of its position on Jan. 1.

During the past two months, though, people sold a lot of shares. Other people (and perhaps some of the same people) then bought them right back. Were you on the right side of the trade? Did you buy more when stocks go on sale, like you should have?

As a retirement investor, it’s important to rise above market timing and trading and the second-guessing tactics of the herd.

And it’s important, of course, to be a buyer when prices fall. Yet you can do this without trading, without reading tons of investing stories in the press and without any special knowledge at all.

Best practices

All you have to do is trick your brain.

The first step is steady investing. When you buy the same amount of investments each pay period, month or quarter, you end up buying more when stocks go on sale and shares are cheaper and less when they are relatively expensive.

The other trick is disciplined rebalancing. In an investment portfolio, it’s often the case that some types of investments will rise temporarily in value as others fall.

Sell some of the relative gainers and use the cash to buy the relative losers — that is, sell high and buy low — and you will achieve better returns over time.

After decades of using these simple investment moves you cannot help but avoid the worst mistakes investors make while taking advantage of best practices. The result is great returns.

Warren Buffett Latest: All You Need To Know

buffett latest

The billionaire investor Warren Buffet released his latest annual letter to shareholders this past week, and it was a doozy.

The letter was full of optimism, a call to investors to shake off worries about the economy and the country’s future. If anybody was ever long the red, white and blue, it’s the Sage of Omaha. Buffett wrote:

“It’s an election year, and candidates can’t stop speaking about our country’s problems (which, of course, only they can solve). As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves do.

“That view is dead wrong: The babies being born in America today are the luckiest crop in history.”

buffett latest

He continued: “American GDP per capita is now about $56,000. As I mentioned last year that — in real terms — is a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently and thereby produce far more. This all-powerful trend is certain to continue: America’s economic magic remains alive and well.”

But the really big takeaway was not about the economy, the elections, the insurance business (which, technically, is his purview) or even the many interesting insights he had on specific investments held by his firm, Berkshire Hathaway.

No, it was this: You should buy stock and hold on to it. Little else in the investment world will serve you as faithfully and as well as a broad, well-diversified investment in the stock market.

“In America, gains from winning investments have always far more than offset the losses from clunkers. (During the 20th Century, the Dow Jones Industrial Average — an index fund of sorts — soared from 66 to 11,497, with its component companies all the while paying ever-increasing dividends.)”

Rugged and basic

The short version of Buffett’s latest wisdom can be boiled down to two simple ideas. Own stocks. Don’t trade.

If you own stocks through, say, an index fund, you will inevitably over time enjoy what’s known as “beta” return, the inevitable increase in the intrinsic value of stocks over time. Meanwhile, chasing “alpha,” that is, extra returns through trading, is a costly and high risk endeavor, one that too often is an outright waste of time.

This is exactly why Buffett himself tells his heirs to put their savings into index funds and just let it go. Over decades, the winners far outpace any losers. You win no matter what.

Portfolio construction, rebalancing, low-cost investing — all of these features are nothing more than extensions of a very  basic, very ruggedly built investment philosophy, often repeated by Vanguard founder John Bogle: “Don’t do something, just stand there!”

An idea with which Buffett would wholeheartedly agree, no doubt.

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