Lee Eisenberg, in his strangely titled book “The Number” (strangely titled, because it actually has very little to do with calculating your Number and reads more like a rollicking yarn … if traveling around the country investigating the financial planning industry seems ‘rollicking’ to you) provides the following ‘memo’ as an example of good financial advice …
… surprisingly, it is good advice – mainly for those in their Making Money 301 ‘wealth preservation’ phase!
It reads like a memo from a junior member of a financial advisory firm to one of their reasonably well-heeled clients:
Dear [Your Name Here],
I wanted to take a moment to outline a few thoughts and ideas before our meeting Friday morning. Some of this may seem old and redundant, but I would like to present this in the context of of your upcoming asset allocation decisions.
1. Overdiversification – This is the single biggest mistake made in managing assets. Once you get beyond three or four funds, you might as well index the whole pool of your assets. If you have more that one bond fund and two or three equity funds you are not really doing much to increase your return expectations or diversification.
2. Value investing works better. Almost all great long-term investors are value investors. Growth investing in the public market works for moments in time but typically does not produce investment results that hold up over longer time periods (i.e. ten years).
3, Don’t be afraid of volatility. If you get your mix between stocks and bonds right, you can use volatility as an opportunity – especially if you are a net buyer of stocks. Your fixed income allocation should meet your cashflow needs and spending plans for the next five years in any environment. So, knowing that your lifestyle needs are met, you can operate as a long-term investor if you have a comfort level in your manager’s investment style. That way you don’t need to be concerned with volatility in the equity market in any given quarter or year.
4. Fees can kill you. In any given year an extra 1% in fees is no problem, but when you get into allocation of large amounts of money to fund low volatility products, arbitrage strategies, and other “alternative” asset class vehicles, you will be spending 2 – 4% of your expected return of 8 – 10% every year in order to achieve the “Holy Grail” of low volatility.
5. If you don’t believe in the fundamentals of any given investment, don’t invest in it. The quickest way to get into trouble is to be seduced by past returns. When you hit the first significant bump, you’ll pack up and get out – this is not a good prescription for long-term investment success.
6. Low turnover is key. Almost no one has made a lot of money engaging in high turnover strategies. It may work for a year or two but the ability to actively trade your way to wealth is all but impossible. When you incorporate the impact of short-term tax rates into the equation, the mountain you need to climb to achieve successful results gets a lot higher. I would be hard-pressed to ever buy a mutual fund with an annual turnover north of 50%. (I make this comment knowing that the average fund manager has turnover in excess of 85% a year, according to the latest studies).
I look forward to seeing you at 10.00 on Friday Morning.
Over the next few weeks, I will try and dissect this advice for those of you in (or contemplating) Making Money 301 …
… for those of you still trying to make your money, heed the advice on overdiversification (better, yet, read my posts on the myth of diversification), the impact of fees (even 1% is too much!), and the benefits of Value Investing over Growth Investing.