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Think Things Through Ahead of Time
I took risks investing in the tech bubble, knowing full
well that valuations were ridiculous, but I was convinced
I would know when to get out. There were two problems
with that. First, I had not defined when that would be:
down 10 percent? 20 percent? 50 percent? Second, when
the time actually came to pull the trigger, I was paralyzed
by the decline that had already occurred. I held on far
longer than I should have, hoping—in this context, a bad
word—that values would come back.
The lesson I took away from this experience is to define
when you will get out—
and
get back in. The time to fix
the roof is before it rains. Similarly, the time to decide
what you will do with your investments when the market
falls is before it actually does.
Greed and Fear Will Destroy You if You Let Them
Whenever I found myself hanging on, trying for the last
little bit of return, I ended up losing most of my gain.
Similarly, when I ran scared, just wanting to get out, I
ended up selling at the bottom. For me, gold—which I have
owned for years—is a good example of this tug-of-war.
When it was going up, I was tempted to buy more. When
it dropped, I was tempted to sell. Recently, I have been more
thoughtful and done neither, but the temptation remains.
When you want to take more risk (because the market is up)
or less risk (because the market is down), you are giving in
to these two demons—and you will probably suffer for it.
Bucketing Helps Psychologically
One way to manage both greed and fear is to assign
investments to specific objectives. That way, you are
focusing on what matters: meeting your goals, which, after
all, is why you are investing in the first place. By assigning
different pools of capital to different goals, using different
portfolios, you can explicitly match the risk of each bucket
with the time frame of the goal.
For example, I have an emergency fund that covers several
months of living expenses that I keep in cash. That makes
it easier to invest my son’s college account, with a 15-year
horizon, on a riskier basis, and my retirement assets, with
a 25-year horizon, on an even riskier basis. Knowing that
my shorter-term needs are met frees me psychologically
to accept the greater risk in the longer-term portfolios.
Losses Are the Real Measure of Risk
Risk is commonly measured by how much returns vary
over time. That does not work for me. The way I see risk
is in drawdowns: how much have I lost from the peak?
When I make money, I figure it is mine—so any losses
hurt. It doesn’t work that way, of course, and I wish I
had been more aware of that in the beginning. Knowing
the shot will hurt may not make it any more pleasant, but
at least you are prepared.
So, yes, I wish some trusted advisor had better prepared
me to cope with the weaknesses we all share when it comes
to investing. Failure to plan, emotional decision making,
and failing to design my investments to help meet specific
objectives have cost me quite a bit of money over the
years. The more you can help your younger clients avoid
these mistakes, the better off they—and you—will be.
Brad McMillan is vice president, chief investment
officer at Commonwealth. He is available at x9269 or
at
.
Things I Wish I Had Known as a Young Investor
BRAD MCMILLAN, CFA®, CAIA, MAI, AIF®
The theme of this issue is reaching next-generation clients, and as I think about
them, I think about myself 20 or so years ago. What do I wish I had known?
What do I wish some trusted advisor had told me? Well, frankly, there are a lot
of things—but let’s focus on the financial ones.
The time to decide what you will do with
your investments when the market falls
is before it actually does.
