Between Greed and Fear: A Prudent Financial Path
Many of us arrive at adulthood with little to no formal education regarding investment management. How much financial management is taught in school or even college? Yet most of us eventually find ourselves owners of a 401(k) or similar self-directed retirement plan. Where do we start? Parenthetically, that is, in part, where I formed my desire to be a financial advisor. The group of mostly young employees I led increasingly came to me to better understand what our 401(k) plan was, as well as how to make wise use of it. It’s a daunting medium. Without sound guidance, we are understandably influenced by financial industry marketing telling us that opening a brokerage account and making money is really quite straightforward. In fact, they do make the process of opening an account quite quick and easy. A little too easy, perhaps. It’s the wisdom to steward our money intelligently which represents the real challenge. After all, at the age of 8 we possess more than enough physical coordination to race a car in a video game, but hardly the perspective to safely travel day-to-day driving a car. The fact that we’ve done well enough to earn some money doesn’t necessarily prepare us to manage it well.
One default mindset is to keep our earnings in cash, safely stored in the bank. After all, reasoned thinking dissuades us from venturing into disciplines which we don’t particularly understand, which feel complicated. The world of investments is indeed complex, and rightfully daunting from the outside. Cash has visceral, concrete appeal: it is unchanging in value, earns a stated and clear rate of return, is easily accessible, and can even be protected by the federal government. Those are significant attributes.
The challenge with investing solely in cash stems from one concept: expected return. More specifically, expected return after inflation. With investments, there is a concrete correlation between risk and anticipated return. Cash can, and periodically does, outperform stocks and bonds, particularly over short periods. Eras vary, and no one can foretell the future, but data from BlackRock paint an instructive picture: In the nearly 100 years between Jan 1, 1926 and Feb 29, 2024, cash has outperformed a mixture of 60% US stocks and 40% US bonds in 28.9% of one-year periods. That’s not an insignificant percentage. However, when we look at longer time periods, the balance shifts. Cash has outperformed this 60/40 stock-and-bond mix over the course of 10 years only 8.5% of the time, and in only 2.1% of 15-year periods. Over 20 years? 0.00% of the time. The degree of that average 20-year underperformance relative to the 60/40 portfolio has been humbling: -384.8%.
What are we to do with these data? We can conclude that cash is not an ideal tool to fill our long-term investment pool. A diversified portfolio comprised of stocks and bonds is a more appropriate fit for periods spanning multiple years or even decades. But cash and cash-equivalents, such as CD’s or Treasury Bills, are beautifully suited for our short-term financial goals, for the reasons cited earlier. How much to allocate to short, medium and long-term goals? Your investment construction should be based on a financial plan. Here, you would work with a financial advisor to help you identify your goals, including the funds necessary to fulfill them. The result could give you guidance on a responsible asset allocation between riskier investments (stocks, including considerations such as size and geographical location) and more conservative investments (think bonds, including considerations such as issuers and durations of bonds). Such a thoughtful investment plan is not based on nebulous notions of desired returns. (“I need to earn 10% per year.”) Nor is it based on fearfulness. (“I’m worried about losing my money.”) One of the most meaningful benefits of such a measured approach is its reduction of the role of emotions altogether by focusing on the longer term, by measuring our success in terms of progress towards our goals. There’s no one to beat in this game; it’s not a medium for ego. Rather, it’s a process of helping our future selves. As marathoners know, finishing with a goal does not mean trying to pass everyone along the course. It means finding an overall pace which will deliver your goal and that you can maintain over the long haul. It’s not always pretty. But a well-run race sure is.
If we know that stocks constitute an essential part of a well-balanced investment plan, do we then simply go online and look for stocks that feel like they’d be good investments? Brokerage firms, to our detriment, can make doing so sounds awfully easy. Remember the fear that we talked about which can dissuade us from placing our money into things which we don’t fully understand? It’s well-placed. How hard is it to choose wise investments? Consider these data from BlackRock: Over the past five years (2019-2023), 64% of individual US stocks made money. Over that same time period, 99.9% of stock mutual funds and ETF’s made money. (I’ll save a discussion of the further benefits of index ETF’s and funds for another day.) If staying on course, progressing towards our goals, is the measure of our success, then the investment method needn’t be crafty, fancy, or perfectly timed. It should be simple, diversified, and low-cost.
How can a financial advisor help? One way is by acting like the “lane keep assist” feature my new electric car includes. If I veer to the edge of my lane (without signaling that I’m turning or changing lanes), it gently nudges me back. While it’s taken some getting used to, the idea of having help in keeping me pointed towards my intended destination is welcomed and appreciated.
With respect to our money, greed and fear are both very real. And legitimate, both as emotions to honor and behavioral drivers to manage. How can we chart a prudent path between them? Educating ourselves is important. Knowledge truly is power, including with respect to choices regarding our money. Asking for help is another. The world of finance is relatively straightforward on one level, and dauntingly complex on others. Having a wise partner as your advocate who can both guide and teach is valuable. Choosing a fee-only Certified Financial Planner™ is a great place to start.
We can do this.
