In continuing last month’s article “The Top Ten Excuses for Not Seeing a Financial Planner”, here is excuse number two: “I don’t like risk”.
To the surprise of many, risk can be useful. Most of us only think of risk as peril or casualty. In finance, however, there are many kinds of “risk” and understanding risk can be helpful.
For a moment, imagine that you’re on an airplane flying at 10,000 feet and standing at the door with a parachute. You’re ready to jump, but you’re uncertain if the parachute will open. That’s risk. Now you go up another 10,000 feet, but you know that the parachute doesn’t work. That’s not considered risk because the outcome is certain. Risk means uncertainty.
As most of us have learned, we can’t predict the economy, and we sure as heck can’t predict the markets. I’m often asked by my clients, “Jeff, where is the best place to invest my money next year?” I have two answers to this question. First, if I or anyone else could predict the near-term future, I’d probably have a cult following me around. My second answer is more serious but almost always the same, “Let’s stay disciplined, goal-oriented and diversified”.
I say this because no one can predict the best returns over a one-year period. In 2012, some of the best returning asset class mutual funds for Dimensional Fund Advisors were United Kingdom small companies (36.4%), International Real Estate ( 32.54%), and Emerging Market small companies (23.09%). Now I ask you, who on God’s green earth predicted the winners at the end of last year? If you find that person, please tell me so I can join their cult.
Because we obviously don’t know the best performers of next year, the best thing to do is hold as many diversified asset classes (foreign, domestic, real estate, small and large companies, etc.) as possible in one portfolio. Doing so in an all stock portfolio returned about 16.5% in 2012. Not the highest return, but certainly less risky than holding all of your stock in one asset class.
The discipline of the portfolio helps us avoid the flawed assumption that there is a trend of higher returns in last year’s best performers. Stocks are not human; they are inanimate and do not have a memory! If we try to predict trends or invest all of our money into one company, chances are we’re going to hurt ourselves financially.
Think about it. Diversity is good for the environment, the work place, and certainly our yoga practice. We do a diversified set of Asanas in our yoga classes. And there’s no way anyone would do handstands for 90 minutes. Why? That’s a good way to get hurt. You need to diversify your yoga practice just like you need to diversify your investments to reduce the chance of getting hurt. And that’s why you let a trusted financial planner look at your portfolio.
Next month, I’ll discuss Excuse Number Three for Not Seeing a Financial Planner: Live for Today, Tomorrow will Take Care of Itself.