Many years ago, we developed these rules to help our new clients learn the behavior that gives them the best chance of success given the way we invest. Call it behavioral coaching, education on markets, or just plain old “rules to be our client”. We found that when we set expectations up front appropriately, clients better understood our approach and more importantly, why we were doing what we did. So this is the fourth in a series of short blog pieces on each rule.
This is a tough one but sometimes the truth hurts. When Bernie Madoff was caught, it was painful to read about the many investors who were duped by this con man. At the same time, I found myself angry with those investors. Many were complicit in the crime. I was conflicted. Since that time, I’ve come to terms with this and I have divided investor victims into three groups:
- Relatively experienced, savvy - These folks should have known better because the promises made to them were simply too good to be true. They were greedy.
- Inexperienced, bright, but lazy – These investors are smart enough to do some due diligence (research) but chose to simply trust Madoff without verifying what they were told.
- Real victims – These people aren’t sophisticated investors and had limited access to advice that might have helped them steer clear of scams.
Interestingly, there is evidence to support that savvy investors are ripped off as often, if not more so, than unsophisticated investors. Either way, this rule for being a successful investor is rooted in knowing yourself and being responsible with your money. Due diligence for a retail investor doesn’t have to be intimidating. You don’t have to read trade journals or text books to keep yourself from being ripped off. Let’s start with some simple rules of thumb:
- If it sounds too good to be true, it is. Use common sense. If someone has a foolproof (or low risk) way of making money, why aren’t they keeping it to themselves? Telling everyone about it eventually (if not immediately) would cause the opportunity to go away.
- If they have such a great system or opportunity, why are they pitching you and not someone who can invest tens of millions? This is assuming you don’t have several million dollars laying around.
- Risk and return are related. There is no “risk free” investment earning 10% per year. Low risk investments (CDs) yield low returns and vice versa. Higher risk investments are a double edged sword; you can lose all or most of your money.
- Liquidity. It’s a fancy word in investing that simply means you can get your hands on your money in a day or two. Most retail investors should have most of their money (if not all) in “liquid investments.”
Let’s talk about advisors. We wrote a blog piece here about choosing an advisor. After hiring an advisor, make sure they explain in detail, in terms you fully understand, how the investments they pitch work. Do not be embarrassed, intimidated, or bullied into making a decision. Good advisors do not use industry jargon to impress you; they are educators first and foremost. Check interest rates levels before buying a fixed income investment like a bond or bond mutual fund. Just visit treasury.gov, click on “Data” and then choose either short term or long term yields. No low risk investment is going to offer much higher returns than these. If you’re being pitched something safe with higher returns than what you see on this site, run the other way. Moderate risk investments like a broadly diversified portfolio of mutual funds made up of stocks and bonds should return more than just bonds over the long run. That means there will be years where they return less and even lose money. You shouldn’t own stocks if you will need the money in less than seven years.
Higher risk investments are properly called “speculative investments”. Speculation has received bad press but it serves an important purpose in financial markets. Speculators provide liquidity for the rest of us to buy into or sell out of markets. But they are professionals (most of them) and know the risks. Individual investors should only speculate with money they can afford to lose! For some, that’s $0 and for others it might be up to 20% of their investments.
The bottom line is to fully understand how your money is being invested. Stating “I didn’t know I could lose it all” is not going to help you after the fact. Take responsibility for your hard earned money.