Whenever there is turmoil in the markets, my phone lights up with calls from journalists, investors and potential clients. They are typically in a panic about the crisis of the moment and are calling for my take on the situation. ¶ In my decades as an investor and analyst on Wall Street, I have learned that panics come and go. They turn out not to be the main cause of investors’ financial setbacks. Rather, what hurts most investors most is a failure to understand the basics of investing. Not grasping the simple mathematical drivers of returns invariably leads to very costly errors. ¶
The best time to make an investment plan is before a crisis, not during it. When the sky turns cloudy, you should follow your plan, including all “exit strategies.” ¶ Consider these 10 points in the context of your own discretionary investments, 401(k)s and IRAs. Identify any errors you are making, and fix them now — before the next storm hits.
1High fees are a drag on returns: Fees are an enormous drag on long-term performance, according to every study that has ever looked at this issue. Typical mutual fund or adviser fees of 2 to 3 percent may not sound like a lot, but compound that over 30 or 40 years, and it adds up to an enormous sum of money.
The typical hedge fund fee structure of 2 percent plus 20 percent of the profit is an even bigger drag on returns. Other than a handful of superstar managers (whom you probably don’t have access to), the vast majority of hedge fund managers simply cannot justify their costs. The same is true for most of the retail stockbrokers and for many of the investment advisers on Wall Street.
Across all of my managed-asset clients, my goal is to keep fees down to an average of about 1 percent. You should expect to pay a little more for small portfolios and somewhat less for much bigger ones.
2Reaching for yield: There are few mistakes more costly than “chasing yield.” Don’t take my word for it — just ask the folks who loaded up on subprime-mortgage-backed securities for the extra yield how that worked out for them.
There are three common ways to chase yield: 1) by buying longer-dated bonds; 2) by buying junkier, riskier paper; or 3) by using leverage, which amplifies your gains but also amplifies your losses.
With the 10-year Treasury yielding just 1.6 percent, I see lots of folks trying to capture more income using some combination of the above. Anyone who engages in this sort of ill-advised, risky behavior should understand the risks and what they might mean if and when things go awry.
3You (and your behavior) are your own worst enemy: Your emotional reactions to events are yet another detriment to your results. Do you get excited about hot new companies? Do you love chatting about stocks at cocktail parties? On the other hand, are there times when you cannot bear to even open your monthly statements? Do your investments keep you up at night?
If so, you, like most people, are an emotional investor. This typically manifests itself in two ways: by the buying of stocks at the highest valuations as excitement builds near the top of the cycle, and by panicked selling near the lows.