Do you have a friend who is considered a “stabilizing influence?” Have you heard the Federal Reserve described as the person who takes the punch bowl away just as the party gets going? Advisors make money when a client does business, but they often help protect investors from themselves. It’s easy to get into trouble if someone isn’t looking out for you.
1. Have a hunch, buy a bunch. They get excited about a stock and “place a big bet.” They also admire those poker players who say “all in.”
Advice: Diversification may lessen the chances of a big score, but it also lessens the risk.
2. If it moves, shoot it. This is followed by, if it doesn’t move, shoot it. If something makes a small profit, they sell. If a stock doesn’t move fast enough, they sell.
Advice: This isn’t investing, it’s gambling. Short term capital gains really allows the government to be your silent partner. “Let your winners ride” is advice that’s been around for years.
3. I’m diversified. I own ten tech stocks. Unfortunately, they are in love with one industry. Those ten companies sell almost the exact same product or service.
Advice: Buy stocks in other industries you feel have potential.
4. I’m diversified. I own five tech stock funds. However, those five funds might own the exact same stocks in their top five holdings. In reality, you might own five almost identical funds.
Advice: Look under the hood at the top holdings in funds you are considering. Are they substantially identical?
5. Bonds are boring. Stocks are exciting. I want to make money. Bonds are for retired people.
Advice: Asset allocation is important. Bonds often act as a shock absorber in volatile markets. If something really does wrong in the market, you’ll probably lose less money than a 100% equity portfolio.
6. Traditional stocks are boring. Those companies aren’t doing anything new. I want cutting edge companies developing new technologies.
Advice: Many blue chip stocks have been around almost forever. They’ve adapted to changes in technology. They often pay dividends too.
7. I’m young. I don’t need to plan for retirement yet. Time passes faster than you think. Remember college? In freshman year, you thought it would never end. At graduation, you wondered where the time went.
Advice: If you start early, there’s less chance of needing to play catch up later. You might even retire early.
8. I’ll just buy an index fund. It’s a compelling argument. It’s hard to beat, because managed money needs to cover fees, just to catch up. If all you buy is one equity index fund, if the market has a down year, so do you.
Advice: Asset allocation and diversification provide the opportunity to participate in other markets that may be doing better.
9. I’m doing fine. I’ll just keep what I’ve got. They feel “You can’t argue with success.” As a Pennsylvania advisor explained, “You may be ideally positioned for the economic cycle we just left.”
Advice: Advisors look into why they did well and what has changed in the meantime. The investor might be right. On the other hand, if a falling interest rate environment has become a rising interest rate environment, the rules of the game have changed.
10. I’ll just own stocks. They outperform all other asset classes. It’s hard to argue. The framed mountain chart on your wall makes the same point.
Advice: This might work if your time horizon is…forever. Markets work in cycles. It’s the volatility that scares people, because you don’t know the timing, depth or length of corrections. Asset allocation and rebalancing helps.
11. Why do I need a cash reserve? Interest rates are so low. Folks who lost their homes in floods, wildfires or tornados probably didn’t see tragedy coming until it was too late. Most people know job security isn’t what it was.
Advice: Cash reserves not only help during tragedies, they also provide capital when opportunity comes your way. You want to keep some of your powder dry.
12. I won’t sell that stock. I’ll have to pay taxes. They really don’t like having the government as a silent partner. They take the risks, the partner shares in their rewards.
Advice: You rode it up. You don’t want to ride it back down again. Diversification makes sense. Historically, we are in pretty low tax environment. It’s likely a long term gain. They may have offsetting losses that can help.
Is the advisor the guy taking away the punchbowl? Are they the string attached to the investor’s kite? These are ways the advisor adds value to the client relationship. In any one of the above examples, you can see how the situation could explode if the investor didn’t get the right advice.
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