Don’t bow down to Wall Street’s latest idol winner
This is the week that a new American Idol champion is crowned.
I found that out when our managing director described to me how the iconic program invaded his little town of Guilford, Conn. recently to honor Nick Fradiani, a local kid who reached this year's final. Ironically, the very next day I had the pleasure of watching my neighbor and YouTube singing sensation Jake Miller take the stage for a pop concert following a Miami Marlins baseball game.
Our ability to communicate and spread the word so quickly today has impacted investing in a huge way, just as it has the entertainment industry. When a singer or actor makes it "overnight" we celebrate with them and admire their accomplishments. But when an investment concept is all of a sudden on everyone's lips and goes "mainstream," the investment veteran in me doesn't celebrate. Because in investing, hype can ruin a retirement portfolio, and do so quickly.
Here are some of today's investment "idols" that I suggest you be aware of. I am not saying to avoid these. But don't fall head over heels for them either (yes, that was a musical reference to the 1980s female band, the Go-Go’s).
Indexing
The initial appeal of index funds was that you can capture the return of the broad stock market. Twenty years ago, you could buy the Standard & Poor’s 500 Index in an index fund, and perhaps a few other major market indexes. Now, Wall Street firms are creating so many indexes that the baloney is being sliced too thin.
They didn't just come up with this idea on their own. Investor demand for more of what started as a good thing led Wall Street to do what it always does: Turn a nice idea for some investors into a glut of products. This lures the everyday investor in, usually when the best days for the concept have passed. I think that is the fate of indexed investing.
In the last six years, U.S. investors have seen the markets for stocks and bonds generally go up. That's why many people love indexing. Because it has worked as far back as they can remember. But when markets go down, those who bought into the indexing idea as an elixir for their retirement portfolio will be reminded that markets also go down, and go down hard. This is an emotional cycle that has repeated itself, from the 1990s to the period after the dot-com crash until the financial crisis, and again since that time. Indexing is here to stay and it has its place in retirement portfolios. But transfixing on the concept is dangerous.
Diversification
Someone once told me that it takes about 17 years for an investing concept to go from the scholar's lab to recognition by the mainstream. The phrases "asset allocation" and "balanced portfolio" were industry terms 17 years ago. Now they are good solid investment concepts gone awry. Markets today move in varying directions, but not when the news is really bad. When that happens, it often doesn't matter if you own large cap, small cap, international, high yield bonds, emerging markets or even commodities.
The only investment class I can confidently say will go up when the broad stock market goes down is an investment specifically-designed to go up when the market goes down. That is why I use inverse exchange-traded funds (single inverse, not the leveraged ones) to hedge our portfolios at Sungarden. You know what you are getting. Diversification isn't about spreading your risk for sake of spreading your risk. It is about avoiding big losses along the way to long-term investment success. Owning 15 asset classes may work some of the time, but just when you need it the most (during very bad market cycles), it can do harm that takes years to make up for.
Performance
What is your investment performance objective? If it is to beat the stock market, ask yourself why. After all, you could invest for 10 years and triple your money, or you could break even. I suggest that each investor personalize their desired outcome, and block out what the markets may or may not do. There is an old saying that "you can't eat relative returns." That's true. If you lose 30%, the fact that the S&P 500 lost slightly more isn't something to cheer about. Think in terms of what you need to live the lifestyle you want, now and in the foreseeable future. From that, your target return to achieve that is likely a more realistic benchmark for many investors.
So, learn to understand these investment concepts but buyer beware: Idol worship can be hazardous to your wealth.