As you can imagine, we meet with a lot of people and see a lot of portfolios. Some are self managed, and some have been set up by another advisor or firm. We’ve found that there are some common mistakes that we see repeated in these portfolios, and others we find ourselves coaching people on most often. To save you the headache of making these same mistakes, here are the top 5 things to beware of as an investor (plus a bonus if you read to the end 😊).
Think bonds, CD's, and fixed annuities here. Even though these may carry some element or combination of fixed payments, fixed interest rates, or a fixed repayment of principal (like with a bond), all investments carry risk! Some investments may not be exposed to as much market risk as say, stocks for example, but that doesn’t mean they don’t carry risk at all. Even the cash in your bank account has risk! Investments that are marketed as “safe” or conservative” typically carry the following types of risk:
- Liquidity risk: You can’t move or access your money whenever you want
- Interest rate risk: When interest rates go up, bond prices fall
- Inflation/buying power risk: Inflation outpacing the investment's return
- Re-investment risk: Having to re-invest money at a lower rate than what you had it in
- Price risk: Decline in value
A great recent example of the real risk "safe" investments can pose comes from the collapse of Silicon Valley Bank. Their big mistake was investing deposits in long-term U.S. Treasury bonds at a time when interest rates were at all-time lows. Note that U.S. Treasury bonds are considered the "safest" investment out there because they are guaranteed by the U.S. government. However, as we now know, they were susceptible to other risk that posed fatal to SVB. When interest rates rose, the value of SVB's bond portfolio dropped, and they had to sell it at a massive loss, triggering their collapse.
Bonds are highly exposed to interest rate risk, in addition to inflation risk, re-investment risk, and price risk. Mathematically, when interest rates rise, bond prices fall. In 2022 interest rates rose and the U.S. bond index declined 13%, its worst year recorded. Additionally, the fixed interest payments will rarely outpace inflation (depending on where rates are), and even though you get your initial investment back at the end of the term, due to inflation, that money is going to be worth less than it was when you initially invested it.
While there are several types of fixed annuities (all of which are subject to liquidity risk and inflation risk) one we've seen become quite popular in recent years is the fixed indexed annuity. Typically these promise that the initial investment can't go down in value, but will earn interest based on the performance of a stock market index. They're marketed as a way to get some stock market return without taking on market risk. That all sounds great, but the downside is that many (not all) of these products can put a very low cap on the interest rates you can earn (we've seen as low as 1%!) and have long surrender periods (we've seen as long as 20 years!). This makes them highly exposed to inflation risk and liquidity risk. In other words, even if inflation was still low at 3% it would be outpacing the return and you'd be technically losing money on an investment you're locked into for a long period of time. This doesn't mean that ALL of these are necessarily bad - an investor just needs to be fully aware of the details and risks.
#2. Using Fixed Investments for Retirement Income
We're still talking mainly about bonds and fixed annuities. Traditionally, it's been believed that as people move closer to retirement they should move more of their money into fixed investments. This is because of the perception that they are safer for retirement income. It's time to rethink that paradigm. Here's why:
The main goal of retirement income is to make sure you don't run out of money before you run out of life. The typical withdrawal a retiree takes from their investments is between 4-5% per year. Take a look at the returns of several asset types over the last 50+ years. More importantly, the "real returns", which are adjusted for inflation. Let's focus on the S&P 500, representing the stock market, and the Bloomberg US Bond Index, representing bonds.
As you can see, the average bond return after inflation is less than 3%. If you are withdrawing 4-5% from that investment, you're retirement "nest egg" is consistently shrinking. In contrast, the general stock market returns about 6.5% after inflation, giving you a much better chance at maintaining a healthy retirement portfolio over your lifetime.
Yes, the stock market has risk, but that risk can be lowered to an extent by what you invest in and how long you plan to be in the market. Retirement is a long time horizon - meaning you are going to be invested for decades. The longer you are invested, the higher your probability for positive returns. Additionally, you can lower risk by: diversifying among many companies by using index funds (we use ETF's), investing in large, well-established companies, and investing in U.S. companies only.
#3. ESG - AKA "Socially Responsible Investments"
ESG = Environmental Social Governance. These are investments in companies that have adopted corporate policies prioritizing social agendas such as minimizing greenhouse gas emissions and diversity, equity and inclusion programs. Investment managers like Blackrock, State Street, and Vanguard use their large ownership of shares at companies to pressure them to incorporate these types of policies. The problem with this is that companies you invest in should be focused on profits. That is what capitalism is about. When companies turn their focus to other agendas, they underperform.
A study was done on the 900 companies making up the S&P 500 (large companies) and S&P 400 (mid-sized companies). Performance between June 2021 and March 2023 was examined (ESG policies became very popular during this time). Here is what was found:
- The S&P 500 itself was down overall by 1.8%
- ESG companies were down 2.5-6.3%
- Neutral companies gained 2.9%!
We found similar results in research we did in-house. We took 10 of the largest non-ESG companies (from different sectors/industries) on the S&P 500 and compared their performance to the S&P 500 overall. The average 5 year return of the non-ESG companies was almost DOUBLE that of the S&P 500: Non-ESG: 17.24%, S&P 500: 9.46%.
The firms and investment managers that hold your money are obligated by law to act in your best interest as an investor, not what they personally believe is best for society. This is why 25 states have brought a lawsuit against ESG allowance in state retirement plans.
#4. Trendy Investments
Investing based on what's rumored to be the "next big thing" is a huge investment mistake. Doing this is called "speculating" and is a lot like gambling. The odds that you are going to strike gold by getting into a wildly successful company at the beginning is extremely small. Its about the same odds that a kid who plays high school basketball has to make it to the NBA. Or that your aunt Doris will win the lottery. The odds are MUCH more likely that you'll just end up wasting a lot of money on companies that don't go anywhere.
As an example, think about internet companies in the late 90's. The internet was new and revolutionary and nearly 2,000 web-based startups went public, all claiming to be the next world-changer. The great majority of these of companies ended up failing and filing for bankruptcy in the early 2000's and only a few survive to this day. Most of the ones who didn't make it were highly overvalued, had no proven track history, and had been operating at net losses. They looked shiny on the outside, but they were fundamentally unhealthy on the inside. The odds that you would've been lucky enough to have gotten in on an Amazon in the sea of options that were out there is very low.
Included in "trendy investments" could be digital assets such as crypto (currency) and NFT's (collectibles). These assets are even more risky as they don't produce anything, thus have no intrinsic value. Even if digital currency is in our future, the government is going to regulate what one is used. The odds of choosing what that might be amongst the almost 23,000 different cryptocurrencies out there are VERY slim - and will be futile if the government creates its own.
Now, it's totally okay if you want to use a small portion of your money to invest in new up and coming companies, but don't put all your eggs in one basket and don't use your retirement money! Also be sure to look at a company's fundamentals - things like their price to earnings ratio (shows whether they're overvalued), their debt, and track history of whether or not they are generating profits to name a few.
#5. Moving In and Out of the Market/Frequent Trading
We've talked about market timing in prior webinars and blog posts, but can't seem to discuss it enough. It is one of the most common misconceptions and mistakes we see made. People think they can get out of the market to avoid downturns and will get back in at the "bottom" when things start to go back up. Many studies have been done that show this is impossible to do on a consistent basis and actually loses more money than simply riding things out. You don't have a crystal ball to predict the market and neither does anyone else - even professionals. If someone thinks they do - run from their advice!
Hand in hand with market timing is frequent trading. This is just another form of trying to time the market by buying and selling "at the right time". Active traders end up underperforming the market by 6.5% annually! Day traders are probably the most severe offenders of this - even though we all know that one person who claims to have made a ton of money in a short period of time. The reality is that only 1% of day traders are profitable net of fees on a consistent basis. It's kind of like gambling - you're just more likely to hear about people's wins than you are their losses.
BONUS - #6. Listening to People Who Aren't Qualified to Give Advice
This is essentially getting investment, tax, or financial advice from people who don't really know what they're talking about. This can be "coffee shop talk" amongst well-meaning friends. Social media and YouTube have also paved the way for a lot of internet "experts" that don't actually have qualifications or experience, but lots of opinions. Watch out for this - especially if they make predictions about what the market going to do or promote any of the other above things we mentioned to beware of. Lastly, don't listen to the news media. Hopefully the last few years have proven that you can't trust their information, resources, or intentions. They profit off of fear and clicks and their goal is not to provide you with accurate information but to hold your attention.
We hope this information serves you and you now know some ways to look out for yourself as an investor. As always, we are here to help if you have any questions related to your portfolio or anything else financial! Give us a call or shoot us an email at email@example.com.