3 Ways to Avoid This Common Investor Mistake
Over the last couple of weeks, we’ve turned our attention to what we believe is an alarming trend in investor behavior and a big mistake. (If I Had a Time Machine What an Investor I Would Be!)
We’ve also shed light on how Wall Street feeds this mistake by enticing investors to zig or zag when perhaps there is no need to do either. (Beware Packaged Wall Street Solutions for Historically Low Interest Rates)
Our hope is that everyone takes a deep breath, understands our caution, and avoids making this mistake in their portfolios. We understand, however, that in periods of extremes it’s easy to fall into this trap.
Times just like today.
There is no doubt that after years and years of falling, interest rates are not just historically low, they are epically low. These low rates have many consequences, and you need to think about your portfolio with the correct mindset.
The mistake or, better stated, the trap investors fall into is changing their investment allocations in periods of extremes. Today that means that many people are questioning their investment in fixed-income securities. They’re now open to chasing other types of investments that appear more desirable on the surface.
We urge you not to do this, and would offer you these 3 ideas to help you understand why:
Your Situation Matters
While financial industry has gone the direction of cookie-cutter solutions, we at Nicollet Investment Management believe that each client has a unique situation. We find pre packaged solutions inappropriate.
What matters are your specific circumstances, and the structure of your portfolio should reflect those circumstances. We spend countless hours working to understand each of our client’s situations, and it’s from that understanding that we construct their portfolios.
When building portfolios, we use two asset classes: equities and fixed income. In allocating amongst these investments, we fully consider both the short-and the long-term.
Over the years, there may be tweaks to investment allocations. Perhaps life changes require adjustments to the plan; maybe the overall value of the portfolio has risen to levels that require changes be made. Nearly every reason to make changes, however, relates to the client’s circumstances, not the markets.
Nonetheless, it’s always tempting to make changes when one type of investment either significantly outperforms or underperforms another.
Now with interest rates at such low levels, the temptation is to view the fixed income as unattractive; to look elsewhere for that money. But that is a mistake.
Fixed-income securities are held for two reasons. The first is for their certainty of cash flows. This reason is all too often under-appreciated. Fixed-income securities carry with them contractual terms that require the issuer to make specific payments at specific times. You do not find this with other types of investments.
The second reason to own fixed-income securities is the income they provide.
Most people will tell you they own fixed income for the income. I would contend fixed-income securities are held primarily for certainty. With this mindset, falling interest rates do not change the reason to own fixed income in your portfolio.
I suggest looking at just the interest rates is wrong, and that when evaluating your portfolio it’s the total return that matters.
In a period of exceptionally low interest rates, we would expect equities to continue to perform quite well. Low interest rates put a premium on growth investments, which is one reason the stock market has been so strong this year.
The key thing to remember is not to abandon the fixed income category simply because yields are so low. Remember—your situation matters.
Stop Watching the Market
I was in a meeting today with a potential client at their office. This particular individual owns a car dealership. Running on the screen behind his desk during the entirety of the meeting was CNBC.
I’m sure it is a habit, one that many have I might add. It’s addictive to watch the markets. Your portfolio can move several percentage points per day in times of high volatility. You’ve worked hard for your assets so it is understandable why one would want to watch them closely.
The trouble with such behavior is that it can make you feel better or worse about things simply because of a moment in time. A moment that is almost always fleeting. Take for example another investor I know—this one the owner of a gas station and outfitting retail shop in Northern Minnesota.
Like the car dealership owner, this individual watches the market tick for tick. On the day of the flash crash many years ago, I received a phone call from him. He needed me to talk him off the ledge. He was ready to sell everything.
My advice at that time was to turn off his devices. “Don’t watch the market,” I said. “Nothing will come of this, and in time what you see today will be vastly different tomorrow.”
It was one of the more gratifying experiences I’ve had in this business. This particular investor did as I advised and stopped watching the markets so closely.
In order to resist the temptation to change your asset allocations because of extreme conditions in the market, the best thing one can do is simply not look.
If you have built your plan and structured your portfolio appropriately, you need to look at things only a few times per annum. Some look more than others and that’s okay. Just don’t be obsessed with it.
Not watching incessantly will help you avoid this common investor mistake.
Focus on Total Return
One of the reasons investors make the mistake of changing their allocations - at the wrong time, I might add - has to do with tunnel vision. Let’s take an historical example.
In the 1970’s stock investing was challenging at best. Equity returns were paltry and interest in equity ownership waned as the decade went by. It was so bad, one publication at the time wrote about the death of equities.
By contrast, fixed-income yields were in the double digits. Many took advantage of the high yields and moved their entire portfolios to fixed income.
Needless to say, that strategy was mistake. But I recognize it’s always easy to pass judgement with the advantage of 20/20 hindsight. Since none of us has that advantage when assessing today’s investment markets, we have to exercise our best judgement.
In order to avoid tunnel vision taking you down the wrong path, we suggest that your focus be on total returns. It is not the return of one asset type over another that matters, it’s the total return of your portfolio that will determine if you reach your goals and objectives.
In assessing the total return potential of your portfolio, you also have to recognize that the returns between the investment types are correlated. In periods of low rates, stocks should do better. In periods of high rates, stocks will do worse.
Owning both equities and fixed income provides balance to your portfolio and allows you to earn a good total return. That balance should be based on your specific circumstances and be unaffected by the recent performance of either investment type.
Focus on your total return.
If you would like to discuss how Nicollet Investment Management can help you avoid this common investor mistake, please give me a call at any time.