As an investment adviser I talk with clients and investors all day long. Some know exactly where they are going and how to get there. Others are very confused about the direction of their investment accounts and don't have a plan to overcome their fears or indecision. I call this latter group "frozen investors" because they don't have a clear cut idea about how they are going to accomplish their goals.
There are a variety of reasons why people may have frozen themselves up:
- History of being burned by an adviser, newsletter, or friendly "stock tip" in the market.
- Having read every opinion or strategy in the financial media, they are experiencing "paralysis by analysis."
- Have been working on their careers or family and not focused on their investment portfolio.
- Have missed the rally in stocks and now believe that the market is ripe for another 2008-style crash.
- Have been conditioned by the media that the only possible direction for interest rates to go is straight up. Therefore they are terrified of bonds.
- They got overinvested in gold or silver and have watched those values plummet for nearly two years.
If any of these bullets sound like you and you find yourself adrift in a sea of self-doubt, I am about to throw you a lifeline. However, it is going to require a shift in your mindset to overcome your fears or preconceived notions.
The first step is realizing that you don't have a plan for your portfolio and that you need help getting back on the right track. It's uncomfortable to be in a place where you don't have a game plan for success. However, it is very easy to understand that you can't continue down the same path and expect a different result. Even indecision is still a decision to do nothing at the end of the day.
The second step is realizing that the markets aren't logical, they are psychological. I have seen many very smart people try to apply logical macro-economic reasoning to investing and ultimately fail. Don't ever forget that an investment can always go higher or lower despite all evidence to the contrary. The stock market can climb a wall of worry when the news is terrible or fall out of bed when everything seems great. Just because the SPDR S&P 500 ETF (SPY) gained over 30% last year does not mean that it can't notch double digit gains again in 2014.
The third step is research and education. If you are reading this article, then you are surely in the mindset that you want to enhance your investment success by increasing your knowledge base. Start out by reviewing some of the investment options that make the most sense and begin sifting through strategies that seem to resonate with your mindset. For my clients, I am a big fan of using exchange-traded funds as a low-cost, diversified, liquid, and transparent investment vehicle. There are now thousands of ETFs that give you the ability to invest in nearly any opportunity or theme you can think of.
The fourth step is decision and implementation. Start out with small purchases of some select investments that you feel will outperform over time. You don't have to go from zero to 100% invested on day one. However, you can start to make incremental changes to your portfolio that will allow you to achieve positive investment results. You can then add to your holdings over time by averaging into existing positions or purchasing new investments.
My recommendation is to pair your portfolio with both stocks and bonds so that you take on a balanced approach and offset potential volatility. The Vanguard Total Stock Market ETF (VTI) is an excellent core equity holding, while the PIMCO Total Return ETF (BOND) might be a worthy fixed-income opportunity. If you aren't comfortable implementing this process yourself, then consider hiring a fee-only investment adviser that will do it for you. Professionals often have the time, tools, and discipline to be able to implement an investment strategy more effectively than if you did it on your own.
The last step in this process is avoiding big losses. In investing there are four certain outcomes: (1) a big gain, (2) a small gain, (3) a small loss, and (4) a big loss. Three of these outcomes are acceptable. Everyone can agree that a big or small gain is going to move the needle forward on your portfolio and even a small loss won't derail you from reaching your goals. However, the big loss is the one cardinal sin that will haunt your dreams and hinder your performance.
The worst part about a big loss is how much harder it is to recover from. Remember that based on the rules of compounding, a 25% loss requires a 33% gain to get back to break even. A 50% loss requires a 100% gain to get back to break even.
Instead, consider using a stop loss or other sell discipline on your portfolio that will allow you to sleep well at night knowing that you have defined your total risk. There are many different ways to implement a sell discipline and I have created a simple guide that may help you gauge the right level for different asset classes.
The Bottom Line
While this approach will not resonate with everyone, it does give you a clear and definable investment path from which to build on. You can pick and choose which ideas you feel are the most closely aligned with your risk tolerance and long-term goals.
The most important thing to remember is that hope is not an investment strategy and sitting in cash is not going to get you anywhere. Stepping out of your comfort zone can be hard at first, but it may just prove to be an opportunity for greater rewards and financial security down the line.