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Perspective on Investing May 11, 2009

Posted by shaferfinancial in Finance.
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Sometimes it is useful to put down in writing one’s perspective.  I am ten years into developing an active attitude toward my personal finance/investing and would like to share what I have learned with my readers.

1. You have to decide what your basic stance toward investing is going to be, either active or passive, or as Ben Graham identifies it, defensive or enterprising.  You need to recognize that by deciding to be a passive or defensive investor you are severely curtailing your ability to both control your financial life and you are reducing your rate of return considerably because you will need to put middlemen between you and your investments.  This will also reduce your psychological ability to properly manage risk because you are depending on someone else to manage that risk for you that doesn’t have the same risk tolerance as you do.  Now I have posted the results many times for the average passive investor as multiple studies have documented.  What most folks don’t think about is how many people are getting a piece of their money when they adopt passive strategies.  Take the person who invests in a mutual fund inside their companies 401K;  The salesperson who brought it to your company gets a cut,  the mutual fund investment company gets a cut, the broker who is performing the stock trades is getting a cut, etc.  Now, how about if your go to a financial adviser; the adviser is getting a cut [whether it is by fee or commission], the mutual fund company, the broker performing the trades, etc. all the way up the line.   Now, you can eliminate some of these middlemen by directing investing into an index fund, but there are still both the investment company and the broker who does the transactions [index funds still trade, a lot, to maintain those index ratio’s and to account for outputs when the market goes down].  The bottom line is whether you are getting advice or not, there are substantial middlemen fees absorbed.  The other half the equation is that it is very rare that a passive investor is emotionally prepared for market downturns, therefore, when the downturn hits the passive investors usually makes mistakes.

The other issue has been discussed in other posts but include the never, ever, syndrome and the fallacy of the efficient market theory.

2.  Diversifying investments is often misunderstood and rarely applied with rigor.  Now I am on record as being a critic of diversifying stock holdings beyond 10 or 12 holdings and personally hold only 4 stocks currently.  However, I am diversified looking  at my entire investment portfolio and am protected to a certain degree by this diversification.  Diversifying one’s stock portfolio or buying a mutual fund should really be called “I am afraid to lose all my money, more than I want to make good returns” strategy.  As I have pointed out many times, diversifying a stock portfolio keeps your losses from being a total loss of capital at the expense of high returns and is skewed toward the downside.

3.  People have totally forgotten about the income producing side of investing, which should be the real goal for folks.  Most of the returns from the last 100 years of stock investing has come from the dividends not from the appreciation of stock prices.  Yet, most people, including individual money managers, invest almost completely for capital appreciation.  For those that are not traders, but are investing for retirement income, it is inconceivable to me why they are not investing in income producing items, i.e. bonds, REITs, limited partnerships, dividend paying equities, investment real estate,  for the specific purpose of building income not for capital appreciation.  You can reinvest the income while you are still working in order to compound the investment income, but you should be tracking the potential income with an eye toward having to live on it indefinitely.

4.  Most people will need all their financial capability working for them during their entire lives in order to accumulate enough assets to live comfortably.  This means they need to put to work, intelligently, items like home equity, insurance, and savings/investments.  At the same time people need to understand and get comfortable with risk.  It is astounding to me how many people, whom are risk adverse in all parts of their lives, have almost 100% of their savings in the stock market in the form of mutual funds.  They have no understanding of the risks they are taking while avoiding risk they should assume.  Human beings, for some reason, have lost the capability to manage risk in their lives.

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