It’s Not the Economy: Here’s Why Your Investments Are Failing

When the financial markets experience volatility and the economy tightens, as it is today, many people point to these circumstances as the reasons their investment plans are failing. But the reality is that volatility is a natural occurrence. History has shown that financial markets and the economy move in cycles.

So, if these market cycles are to be expected, why do many investors still struggle? Following are some of the most common reasons and suggestions on how to avoid these pitfalls.

 No clear goals for the portfolio. As with many aspects in life, having a clear goal creates a clear direction and improves the odds of success. What are the goals of the investment portfolio?  “To make money” is rarely a true (or effective) goal of any portfolio. Goals should delve deeper and be more specific. Examples might be to retire maintaining the lifestyle one has become accustomed to (or to improve it), to pay for a child’s education, or to support parents during their golden years, to name a few.

Concentrating on return; ignoring risk. Too often, investors concentrate on possible returns without realizing what risk is needed to obtain that return. There are many opportunities for large payoffs that require you to risk losing everything. Most investment opportunities are not that dramatic, but investors should understand what risk they are taking (and are comfortable taking) prior to making any investment.

No rebalance/sell discipline. Many investors take the time to research particular investments before making the decision to buy. But few conduct the same due diligence to learn what circumstances would necessitate increasing or decreasing the size of that investment within their overall portfolio. Knowing when to adjust – or rebalance – one’s portfolio by selling particular investments is a crucial component of any successful investment strategy.

Lack of diversification.  A portfolio invested primarily in one market sector runs the risk of that sector failing, but also stands to gain from any upside of that sector. For most investors, the potential downside risk carries more weight than the potential upside return. A diversified portfolio should include investments across many market segments and sectors to help balance risk and reward. A few areas of diversification that may be overlooked are foreign exposure and small capitalization exposure (both domestic and foreign).

Buying “products” rather than solutions. Investors are constantly offered investment products. Although products are necessary, they should be the final piece of the equation, not the first. Rather than start with a product, look at the end goal. Review the various solutions available to you and decide which product(s) is the best tool for the desired solution.

Taking too much (or too little) risk. Some investors take too much risk, in hope of a windfall. Others are more worried about losing what they have than they are interested in getting more. Understanding how much risk an investor can or should take is an important key to the overall success of the investment plan.

Risk is a difficult concept to measure, of course. It can be measured by academic formulas, which have both benefits and drawbacks. Risk can also be measured by “comfort” of the investor with the portfolio. A combination of both measurements may be the best solution. Once goals have been set, risk can be measured as a probability of meeting the desired goals.  If the goals can be met with a “less risky” portfolio, that may be a viable solution. On the other hand, there may be times when an investor needs to take more risk to increase the probability of meeting the desired goals. In such cases, if an investor is not comfortable with that level of risk, it may be necessary to modify the goals.

Thinking short term. Risk is directly related to the investor’s time horizon. Market returns are not linear; they ebb and flow with short-term economic cycles. Historically, investing in the financial markets has provided superior results when investments are made and maintained for the long term.

Making emotional decisions. Typically, investors are fearful of putting their money into bear markets when there is often good value to be gained over the long term. Conversely, investors often become greedy and invest too heavily during rising markets when the true growth potential is slowing and coming to a close. An example of this is the tech bubble of the late 1990s that not only pulled a lot of investors in too late in hopes of getting extraordinary returns, but also made them nervous and kept them out of the stock market after the detrimental burst when other equities were taking off. Simply put, emotions can get the best of investors and keep them from achieving the full potential of the stock market in the long-term.

There is no plan. Perhaps the most common reason why investment plans fail is that the investor doesn’t actually have a plan. All of the points previously outlined in this article will factor into developing an investment plan. Once you’ve developed a plan, put it in writing.  Review the document and portfolio on a regular basis (quarterly or annually, not daily) and make changes as needed. The old adage “people do not plan to fail, they fail to plan” is never more true than in creating and maintaining a portfolio.

Going it alone. Keeping track of all these key issues is a big job, and most investors don’t have the time or education to do it alone. Working with a trusted advisor to create and maintain an investment plan will help ensure success in the long term. Competent investment advisors work with clients to determine their personal and financial goals, needs and priorities; understand their time frame for achieving results; and discuss their tolerance for financial risk. Having a comprehensive knowledge of diverse financial issues — such as taxes, investments, retirement planning, estate planning and insurance — enable advisors to help clients understand long-term planning and the big picture. Above all, an advisor must take seriously his fiduciary responsibility to always place the client’s best interest as his highest priority.

 

About the author

Bob Burger, CFP®, CDFA™

7 Comments

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  • Steve – My experience is that an average percentage for assets under management of 500 thousand dollars would be 1% annually – typically billed quarterly (.25%). A $500,000 would be billed $1,062.50 quarterly. When considering an advisor who is compensated via commission, charges vary and are often based on the product sold. Be sure to measure all payments to the planner. Some may charge less, but be compensated in other ways (often called fee-based which is different than fee only). I would argue that 1% should include financial planning services and not just asset management. Given that you are in retirement, planning services may include reviewing financial goals and testing the likelihood of outliving your resources – with solutions that would increase the likelihood of success. A simple test to see if planning is part of your package is to reflect on the most recent meeting with your advisor. Did the advisor concentrate on the performance of investments or did they ask about other areas of your life that have financial implications? Typically, planners spend more time talking about changes in your life’s circumstances than on how each mutual fund or stock performed. I hope that helps.

  • Thanks Joe. My assumption is that you are looking to educate rather than ensure you leave them an inheritance (which may also be the case). If this is true, have you considered helping them create a financial plan based on their needs, wants and goals? Based on your success, you undoubtedly understand the benefits of having a financial/investment plan.
    Today’s children are taught the value of building a plan in so many areas of life, but financial/investment plans are often neglected. As a young adult, I was told I “should” be saving and contributing to a retirement plan, but no one ever sat down with me to share the reality of those decisions. This lack of education may have been caused by the fact that many of our parents and grandparents never considered investment decisions because this “task” was outsourced to a professional (pension fund). They may not have the knowledge you have and therefore couldn’t share – even if they wanted to. While your initial request was for an investment vehicle or family type of scheme, I feel education is a better solution.
    I applaud your desire to share your investment knowledge with your family. It has been my experience that children are watching much more closely than we think. Your children probably have greater financial knowledge than you think. One note…if you seek outside help in the creation of a financial plan, be sure the plan is based on education rather than a ploy to sell products.

  • I have been a long time investor for some time and of course, I have become more conservative as I became older but I have stayed the course. I am trying to get my children and grand children to become more involved in creating wealth. They have all either graduated from college or in college but they are not wealth literate, yet! I want to create a family type of investment scheme for not just my children’s generation but also for generations to come. I am not quite sure what kind of investment vehicle to use but it must be family inclusive. Any ideas?

  • Good question Jesse. I am not sure someone’s goal should be to build a portfolio that withstands changes in the economy. Many investors believe the goal of an investment plan is to outperform the “market”. Unfortunately, research shows this rarely happens – especially after considering expenses and taxes. A better way to manage fluctuations in the economy is to accept them when creating a financial plan. I understand the desire to manage short term fluctuations in the economy or avoid market risk. However, a properly executed investment plan is constructed to best achieve the investor’s goals given their time horizon with the understanding there will be negative returns along the way. Volatile markets often create the desire to find a “new, better” solution. Sticking to a well thought out financial plan – based on the investor’s needs and goals – is a better long term solution. Thanks for your question.

  • How can someone create an investment plan to withstand the changes in the economy while investing in stocks, bonds and real estate? Is there more areas you will have to or should invest in? How might someone go about setiing up this type of investment plan?

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