Fundamentals of Investing

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fundamentals of investing wisely. Over the course of the book, we'll be talking about tracking your investments, divers...


Fundamentals of Investing: Strategies, Concepts, and Principles

Fundamentals of Investing: Strategies, Concepts, and Principles

Copyright © 2015 by Timothy J. Clifford CFP®

All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means including photocopying, recording, or information storage and retrieval without permission in writing from the author.

Printed in U.S.A.

Table of Contents Introduction ............................................................................................ 4 Chapter 1 .................................................................................................... 5 Tracking Your Investments .............................................................. 5 Chapter 2 ................................................................................................... 8 You Need Patience – Take a Long-Term Investing View ...... 8 Chapter 3 ................................................................................................... 13 Core/Explore Strategy ......................................................................... 13 Chapter 4 ................................................................................................... 16 Diversification........................................................................................ 16 Chapter 5 ................................................................................................... 20 You Must Control Your Investment ............................................. 20 Expenses .................................................................................................... 20 Chapter 6 ................................................................................................... 24 Understand Your Risks ....................................................................... 24 Chapter 7 ................................................................................................... 27 The Investor’s Triangle ....................................................................... 27 Conclusion ............................................................................................... 29


Introduction T

he idea of investing, creating a nest egg, and building wealth sounds great. However, sometimes it is not as easy as simply contributing to a 401(k), buying a stock, or starting an IRA. You need to have a strategy. Moreover, you need to understand what it takes to invest smartly. You need the fundamentals. This book aims to help put you on the right path so you can understand – or for some of you, revisit – the basics of investing. Whether you have invested for decades or are just beginning, this book shares what I consider to be the fundamentals of investing wisely. Over the course of the book, we’ll be talking about tracking your investments, diversification, understanding your risks, and much more. By the time you finish the book, you should have learned about – or been reminded of – a few new strategies, concepts, or principles. Let’s get started!


Chapter 1 H

Tracking Your Investments

ow do you know how your investments are doing? For that matter, how can you evaluate whether you need to make any changes to your strategy? Most successful investors tend to keep good track of their investments. They track them and evaluate how they’re doing versus what their expectations were. As an example, if they built a portfolio with a Beta of .80 versus the S&P 500 (we will visit this concept later), they will regularly review market fluctuations to make sure their portfolio is performing at about 80% of the S&P 500 and make adjustments accordingly. These reviews help them to keep them on top of their investments, and this is what you should be doing as well. While this might seem like a simple enough concept, many investors still have trouble with it. Many investors love tracking their investments when the market is on the rise and they are doing well. However, as soon as things start to go south, they quickly lose interest, and adopt a don’t look strategy. What I have discovered with the investors I’ve helped is this: it is important to understand their emotional state and their reactions when it comes to investments. What did they do during the 2008 correction? How did their investments fare, and what happened afterward? By understanding these things, it becomes easier to understand 5

what you really need to do to improve your investment strategy. Let’s look at an example of a couple that I worked with. When I asked them those two questions mentioned above about 2008 and what happened afterwards, they said that they didn’t fare badly during the correction, and they didn’t make any changes because they were only down about 10% or so. What I discovered was that their portfolio was actually down by more than 10% during the recession period. Instead of actually looking at their statements and trying to make changes that may have benefited them, they buried their heads in the sand and ignored them. Why would someone do this? Well, it’s the easiest thing to do, human nature being what it is. In fact, this tends to be the default strategy of far too many investors today. Of course I’ve seen a number of clients who were on the opposite end of the spectrum as well, which might even be worse. They tracked their investments obsessively. Whenever something went wrong, they panicked and lost a substantial amount of money because they sold out – right at the bottom of a market cycle. You need to find the middle ground, the Goldilocks Zone. Set up a process where you are aware of how your investments are doing – both short and long term. In most cases though, you only want to do an in-depth review of your investments several times a year and to make adjustments if needed. This strategy will keep you from being on either extreme. It also means you are only making changes to your investments periodically, which if you have a good investment strategy, is quite enough. Have and follow an investment plan. It doesn’t have to be complicated either. It might be as straightforward as 60% in the S&P 500, 30% Global Bond Fund, and 10% cash. Then your changes are simply based on rebalancing, or wanting to add or take away risk. In summary, tracking your investments does not mean trading or making constant changes to your portfolio(s). We will get into building a diversified investment package later in the book. For now, just remember that tracking 6

your investments is the foundation to a good investment strategy, and in my opinion a fundamental principle to being a good investor. In the following chapter, we’ll be talking about how and why investors need to be patient, and why they have to develop a long-term view of investing.


Chapter 2 You Need Patience – Take a Long-Term Investing View


ne of the mistakes that many investors tend to make is not thinking in the long-term. In a world where the news cycle is 24 to 48 hours, long-term sometimes feels like maybe a month, a year or two. When I am referring to long-term, I mean a decade or more. Many investors lack patience and they want to see results right away. To quote Warren Buffet, “Our favorite holding period is forever.” Although this is not always advised or practical, it is a great long-term view of investing. Looking at investments from a long-term perspective is an investment principle you want to strive to adhere to, although you should have a process in place to review and monitor all investments for changes in their fundamentals to ensure they are investments you should continue to hold. People also look at the headlines in the news and worry that the market is going to crash, or that the market is on the way up, or… you get the idea. Too few of us are actually looking at the larger picture. Franklin Templeton Investments, however, did look at the bigger picture and wrote a piece on the Bull and the Bear markets over the past 85 years, starting with the Great Depression through to today, and categorized them by decades. They broke the decades down according to the main factors that caused shifts in the market: • • • •

1930s – The Great Depression 1940s – Economy Spurred by War 1950s – The Eisenhower Years 1960s – Conformity Gives Way to Social Revolution 8

• 1970s – Energy Crisis Sparks Economic Crisis • 1980s – Reaganomics • 1990s – The Longest Bull Market in History • 2000s – The World Greets a New Millennium • 2010s – the iGeneration Engages in Global Transformation The document provides a good look at both the ups and downs. By looking at the overall picture, investors soon realize that success doesn’t have to come right away. The best things, and the best investments, will often take time. Like the title of the chapter says, you need to have patience. Some Tips for Long-Term Investing When thinking about long-term investing, you want to make sure that you avoid some common mistakes. Let’s look at a couple of tips that can help you keep a long-term perspective. Tip #1: Have a Plan and Work the Plan First, consider having a plan for each investment account. You might hear this strategy also called an Investment Policy Statement (IPS). An IPS can be a simple onepage document that outlines how you are going to invest a particular portfolio. As an example, you might have decided you want 65% of the portfolio in Stocks and 35% in Bonds and Cash. You then decide what types of stocks and/ or bonds such as US, International, Large Cap, Small Cap Value, and so on – this list of possibilities is almost endless. The point is, you decide in advance of a market correction how you will invest and then invest accordingly. Part of the plan will also include a process you need to go through to identify your personal risk tolerance, which will help decide how much you invest in each of the categories. While advisors (or computers for that matter) may be able to give you great advice, remember that it is your money at stake. Never invest blindly or in investments you do not understand. 9

Tip #2: Don’t Go It Alone Second, hire and pay someone to help you build, implement, and keep the IPS mentioned above on track. I know, I know…for some of you a financial advisor ranks below your dentist when it comes to wanting to talk to them or visit with them. In my opinion, this is because you have not spent enough time trying to find an advisor who matches what you expect from a financial advisor. There are all kinds of investor models out there… from full service face to face, to once a year reviews online for a small flat fee…and everything in between. Do not be fooled into thinking your knowledge about investments is expertise. Knowledge is taking information, filtering it, prioritizing it, and employing it in a useful way. Expertise is information + knowledge + time. No matter how smart you are, how much you read or how fast you learn, you cannot obtain expertise without time. I personally think Gladwell has done the best job defining it: “It is 10,000 hours doing a specific thing”. Spend the time and money it takes to hire the right advisor (expertise) – not your brother-in law – to help you build, implement, and keep your investments on track. Tips #3: Investing Is Not a Game or Hobby Third, do not try to chase the latest and greatest investment idea. When I listen to some of these investment shows, they sound more like pre or post game shows on any given Sunday during football season. I know it can be entertaining and even fun, but separate investing your retirement account from the noise and excitement the media creates. If you are someone who likes to do a little research and make individual investments, we will discuss a strategy that can help you do this while keeping your overall in10

vestment goals in place. This strategy, by the way, is called Core and Explore. I Understand Your Worries I’ve been working to help clients make the most of their investments since 1985. In that time, I’ve seen seven bull markets and seven bear markets. I’ve seen the wisdom of that old adage that what goes up, comes down. As well as, what goes down also comes up again when it comes to the over-all market. Naturally, most investors will still have some element of anxiety when it comes to their investments, including their long-term investments. Still, with experience, a plan you believe in, and the help of an advisor, you should understand and feel good about the investment decisions you are making. If you still have some reservations about the investment strategy you are using, then you will likely want to speak with a financial advisor about the situation. Remember, there are lot of different financial firms and advisors out there; finding one that meets your expectations is worth the time you take to do so. Please keep in mind that it is always important to make sure that you are comfortable with your investments, and that the strategy you choose is in line with your risk tolerance as well as your time horizon. This will help you to stay invested in your own future. When the market starts to go down, it can be very tempting to want to sell and then get back into it once you think it is going up again. However, I do not recommend this strategy. If you do this, you now have to be right twice. What I mean by this is you need to be right about when you are going to sell, and then you need to be right about finding the proper time to buy. This is extremely difficult, and as I’ve been an investor as well as an advisor for 30 years, I can say this with some confidence. In summary, think long term when it comes to your investments. To do this, build an investment plan for each investment account, hire an advisor (at least for your core portfolio which we will discuss in the next chapter), to help 11

keep you on track and then live your life. Do not obsess about or even listen to the doomsday scenarios, the next great investment pitch, or someone who sounds like an expert but actually is just knowledgeable. (i.e. your brother in-law, neighbor, or that guy at church!)


Chapter 3 H

Core/Explore Strategy

ere is a strategy that allows you to assemble a bucket of your investment assets in a way that seems easy and natural. I have found that many successful investors have different investment strategies and objectives for different investments. As an example, an investor might own the company stock where he or she works, or have an investment in a rental property. Both of these investments are part of their over-all investment strategy, but how they view them and make decisions about them are different from how they might another investments I used to work at Charles Schwab, and when I was there, there was a strategy that we shared with our clients. Most of the clients found it to be very easy to understand and to implement, and many were already doing it without realizing it was an actual strategy! It can help you build wealth with a little more intentionality, so let’s look at what it’s all about so you can get started. In the Beginning When people make their first investment, it is generally something small and something that people don’t really put much thought into, such as a mutual fund with a 401(k) or an IRA. Later, people will often venture outside of their retirement fund for investments. Perhaps they will invest in a company’s stock or buy a mutual fund. Years later, these individuals find that they have a number of different investments and accounts. For many people, this is all they do. They see that they have several different investments, and they believe that they have a diversified portfolio. However, even though they might have some diversification, the combination of all these investments is usually not a disciplined strategy to ensure that they are invested 13

across some of the common core assets – and in proportion to their risk tolerance, goals, and objectives. This is where the Core/Explore strategy can help. What Does the Core/Explore Strategy Do? The Core/Explore strategy allows you to keep the investments you currently have, but allows you to start building a Core Investment portfolio and build a personal portfolio that is invested in the same manner as many foundations and pension accounts. These types of accounts invest based on a disciplined approach. Each investment category is based on the account’s risk tolerance, their time horizon (i.e. when will they need the funds), a quarterly review of all the investments, cost effectiveness, and periodic adjustments. What makes this strategy so practical and easy to implement is you can get started with just a small portion of your overall assets. The core of any object is smaller than the whole, sometimes it is only 5%, while other times it can be 25%. With this in mind, start a small Core Portfolio and as you find yourself with cash to invest, consider adding some of it to this portfolio. Over time I think you find this portfolio to be the ‘go to’ investment for new money. I have found it might start out being 5% or 10% of an investor’s overall investments, but by the time they have implemented it for a decade or more, they find their Core Portfolio is a lot more percentage wise then when it was started because 14

of the predictably, ease, and swings in value compared to other investments. In summary, a Core Portfolio is not just a single investment. Instead, it is a portfolio that is usually professionally managed, has investments diversified across different types of asset classes, and is allocated according to the risk tolerance, objectives, and time horizon of the portfolio. In the next chapter, we’ll talk more about diversification and why it is so important. Core/Explore is a simple strategy that builds off what you’ve already started. You will find that it doesn’t involve taking massive risks or altering your investing mindset.


Chapter 4 O


ne of the terms that we’ve already touched on, and that you often hear when it comes to investing, is diversification. People understand that it’s a good idea to have a diverse portfolio, but they don’t always know what that means. They might think that they have a diverse portfolio because they have five or six investments, but some people are still investing too narrowly to be truly diverse. Your goal when it comes to diversity should be to have a portfolio that has some predictability based on how it performs relative to the S&P 500. Whew…that’s a big concept and a long sentence! Now what exactly does it mean? The Word of the Day: Beta There is one word you want to know when it comes to diversification, and as experienced investors will tell you, that word is ‘Beta’. There are whole books written about this concept, although for our purposes, keeping it on a basic level should be enough to make the point and help you understand a concept that will make you a better investor. Beta is a simple metric and is easy to identify for each and any investment. There is a Beta for stocks, bonds, mutual funds, ETF’s and portfolios. Let’s start with the definition: Beta measures the volatility, or systematic risk, of a security or a portfolio – usually in relation to the S&P 500 index. Okay, so now how does it relate to building a diversified portfolio? In my opinion this is a fundamental number to look at because it provides you with an immediate idea of how diversified an investment portfolio is. To illustrate this, I will use a football metric I think most of you will be able to relate to, whether you’re a gridiron fan or not. 16

The wide receiver on most teams is usually the fastest runner. Knowing this, you probably want to evaluate a wide receiver’s speed. It is not an end-all or be-all number, but it does give you a simple and easy metric to evaluate his ability to be a good wide receiver. In much the same way, Beta helps an investor identify how much risk is associated with an investment portfolio. I personally look at the 3 and 5 year Beta number on a portfolio just like a football scout might look at a wide receivers 50 and 100 yard dash numbers. Here is how Beta works. The market – specifically in our example the S&P 500 – has a Beta of 1.0, and your portfolio is scored according to how much it deviates from the market. If your portfolio swings more than the market over a specific period in time, it has a Beta above 1.0. If it moves less than the market over the period in time, its Beta is less than 1.0. A high Beta portfolio is supposed to be riskier but provides potential for higher returns; low Beta stocks pose less risk but also lower returns. Now let’s look at an example. If you consider a Morningstar Portfolio report, it will show you the Beta for that portfolio over a 3 year, 5 year, and in some cases a 10 year period. It will report a number such as a .80 Beta over the last three years. This means if the market goes down 10%, this portfolio (in theory) would go down 8%, and then vice versa on the upside. If the market goes up 10% this portfolio would be up 8% according to its 3 year Beta. As I stated earlier, as with most things, this is not an all encompassing strategy. Investing is part science and part art, but the Beta number gives you guidelines that are easy to review as to the volatility and/or risk associated with a portfolio. I do find it frustrating when I talk to investors and their accounts have a 1.0 Beta for the most part and they are paying a decent fee to an advisor to manage it. In many cases, if you have a 1.0 Beta, you can just buy the S&P 500 Index and do it for a lot smaller advisory fee. Understand Where Your Investments Are As a financial advisor my focus is on downside risk…not 17

upside returns. I know this might sound backwards but from my experience, clients tend to make more bad decisions when they are fearful than when they are greedy or wanting more returns. It is pretty simple – more return equals more risk – and most of the investors I meet want more return but do not want the risk. If you want more return, do it with ‘explore investments’ and keep your Core Portfolio in a disciplined investment process aligned with your risk tolerance. Here are some questions that I ask people who come to me for investment advice. How would you answer them? First, I will ask them if they are really diversified, and many believe they are. Then, I ask if they have a natural resource investment? Do they have a real estate investment? When they look at their portfolio report, are all of three equity styles represented (Large cap, Mid cap and Small cap)? Does the portfolio actually align with their investment goals, including risk tolerance? How did you answer these questions? If you were able to answer yes to all of them, that’s fantastic. It is likely that you are an informed investor and you probably have a diverse portfolio. If you give your advisors free reign when it comes to making investments for you, it is still important that you take time to review your investments and keep up to date with them. Technology has made it very easy to keep on top of things. You can check reports online in a matter of minutes. And the fact is, you are never far away from a report that will let you know right away how your portfolio is doing. What Is Proper Diversification? One of the things that you need to understand about diversification is that everyone, including every advisor you meet, will have an opinion on what the ’best’ diversification would be. Most of the time, the opinions will vary. Some feel that having several stocks and several mutual funds is all the diversification you’ll need. Some say that you also need real estate and natural resources in the mix. 18

My personal belief? I think you should have a portfolio that has investments across seven core asset classes. These include: • • • • • • •

US Equities International Equities Real Estate Natural Resources US Bonds International Bonds Cash

The amount of money you have invested in each of these asset classes will vary based on your investment objectives and your risk tolerance. In the end, the right amount of diversification comes down to your goals. Just keep in mind the seven asset classes mentioned here, and try to spread your wealth into those different areas as much as you can. Talk to your financial advisor about your options so that you can develop a truly diverse portfolio. Of course, this doesn’t mean that you have to rearrange your entire portfolio today. You can take things slowly and build your diversification over a longer period of time, just as you built your investments. Just make sure that you track and review your investments regularly so that you can make changes and adjustments as needed. If you aren’t tracking your investments as we mentioned in an earlier chapter, and you don’t know what you have in terms of investments, you probably are not going to see as much success as you might want.


Chapter 5 You Must Control Your Investment Expenses


know what’s on your mind when you’re thinking about hiring a financial advisor. I’ve worked with hundreds of clients over the years, and I understand that even as they consider working with an advisor, one question keeps going through their head. It’s in yours right now. “How much does all of this cost?” They might like the idea of having an advisor to help them with their investments, but they do not want to spend what they may consider a lot of money to work with one. Plus sometimes it is a combination of paying for an advisor and having to deal with one when you think you basically know what you are doing. It’s understandable. After all, investing is about making money, not about spending it! The next question people often ask is, “Just what is it I get for spending that money?” I believe that a client deserves the answers to these questions right away. They shouldn’t have to work with advisors who avoid directly answering their questions just in the hope of gaining a new client. The answers to your questions should come quickly, and they should be easy to understand. You do not want to deal with any hidden fees, so you need to look for an advisor who is transparent about the costs. Keep in mind that 20

the actual prices and costs can vary for a number of reasons. Here is a summary of four common fees and expenses you may incur when investing. What makes the exercise of figuring out how much you are paying so complicated is that it can be difficult to do an ‘apples to apples’ comparison. This is because firms and advisors all charge a different combination of fees…they might use percentages one time and dollars other times to calculate their fees. Let’s look at them in detail, and then I’ll show you an exercise that will help you to do a comparison. Account Fees The account fees are generally charged on an annual basis. This is the fee you are paying to do business with the financial firm, and the prices can vary. Most will tend to charge between $15 and $50 a year for each account. While this might not seem like much money, it can add up. As an example, you might have two IRA’s, a joint account, and a custodian account to help educate one or more of your children. That’s four accounts. If you don’t have enough money invested through the firm to have these fees waived, it may cost you as much as $100 a year just to have four accounts registered with them. Brokerage Fees and/or Commissions If you make an investment, or you change one of your current investments, the firm you are invested with will generally charge a brokerage fee, (or sometimes it is called a commission). The amount is usually either a set dollar amount or a percentage of the investment, but the price can and does vary between firms. As an example, it might be between $7 and $100 per trade, or 1% or 2% of the amount traded. If you are investing in a mutual fund with a commission, the charge is going to be a percentage of your investment. Again, the amount can vary, but it will generally be between 1% and 4.75%. This is usually only charged when you invest in the fund. The mutual fund companies do not 21

generally charge a fee or commission when you sell them, although the investment firm you are working with may well do so. Investment Management Fee The investment management fee is charged with investments that have multiple investments inside the investment, such as a mutual fund or ETF. There are no investment manage fees associated with individual stocks. Morningstar Reports make this fee easy to find and it will usually be quoted to you as a percentage. Another term for this is Net Expense Ratio, so make sure you check for that as well. This is the fee the money manager charges for managing an investment. The percentage is usually relatively small, but the range is massive – from 0.1% to 1.2%. Do not fall into the trap of believing that lower is always better. It really depends on the investment and your objectives for that investment. Advisory Fee One question you should ask in this process of understanding how much you are paying is “How does my advisor get paid?” Generally he or she will get a percentage of the commissions and/or the advisory fee charged. There is a difference in the two, though it may not look or feel like it to you as a client. If the advisor is only charging a commission to buy or sell a product, you are paying for this advice based on the information he or she knows about you at that time. Basically, it is a one-time advice fee. If the advisor is charging an advisory fee, you are paying for ongoing advice, and as your life events occur your advisor should be made aware of them and advise accordingly. I had it explained to me by an industry attorney this way. If an advisor is being paid a commission it is based on a picture. If the advisor is being paid an advisory fee it is based on a movie. As a client, I recommend you use the latter whenever possible. In summary, not all accounts, advisors, or firms will charge an advisory fee, but if you are being charged one it 22

should be easy to identify and calculate. Understand the Fees The simplest way I have found to do a fee comparison is to write out a table with six columns. On the top of the first column write the Firm Name, then in the next write Account Fees, and so on. Then fill in the boxes with a dollar amount for one year based on the same amount invested with each firm. It is not perfect because you are still estimating some fees and expenses, but it does give you at least a high-level view and a general idea of what you are paying to have your money invested.

When you are working with a firm, you should have them explain all of the various fees they charge, and be sure that you understand those fees. The total investment costs should be aligned with the value you think you receive. There is not a right and wrong answer here. It comes down to the perceived valued you think you receive. The point I make to current and perspective clients and want to make to you here is that you should know in general terms how much you are paying in dollars each year for investment advice. Then you decide if it is of value or not. Too many investors seem to invest and have no idea how much it is costing them to do so.


Chapter 6 O

Understand Your Risks

ne of the most important things to know about investing is that even when you have “safe” investments, there is always an element of risk involved. It’s the nature of the markets. When you are developing your investment strategy, it should always start with risk. You need to know how risk tolerant you are when choosing your investments. Those who have a low tolerance to risk will, of course, want to stick to the investments that have the lowest possible risk involved. Many times, they also have the lowest reward, but that does not always matter. When you think about risk first, and not the amount of money you could potentially make, you will find that you tend to make smarter investments overall. Whenever you’re thinking about an investment, it is natural to get excited about the potential to make money. What you need to do is to step away from that excitement and get out of the habit of looking at an investment from a worst case versus a best case scenario. Look at the potential risk involved and how much money you could lose. Investment Simulation One tool available to help investors both mitigate and better understand their potential risk in an investment is a simulation known as Monte Carlo. This involves using a computer program to look at the history of the investment, 24

utilizing different periods and sources of uncertainty that could affect their value, and then finding all of the different potential outcomes. It produces a ‘cone’ illustration, something like what you see when the weather experts are trying to predict the path of a hurricane. You will see the extreme on the upside, a median line, and then the extreme on the downside scenario. This provides a visual report that can help to put an investment (or a potential investment) in perspective.

Managing Other Types of Risk When you have investments and any measure of wealth, you will also find that risks are involved. You have to deal with market risk, inflation risk, and interest rate risk. These are elements that you can’t eliminate, but you can do some things to help manage them better. You can’t ignore the risks; you need to manage them. Sometimes, I meet potential clients and they say “I do not want to take any risk. Put my money in a CD or something guaranteed.” This is an example of an unrealistic ask. Not that such investments don’t exist, they do…but that doesn’t mean they don’t have risk. If you have any wealth and assets that need to be managed you have risks! Here are three common risks I try to help clients manage… Market Risk Market risk is the most common type of risk you need to manage. Fortunately, there are many tools out there that can help you get a good idea of the amount of risk different types of investments carry. Keep in mind that I mentioned in a previous chapter how diversification involves seven different asset classes. You need to understand each of the classes where you have investments in order to help mitigate your risk. 25

Inflation Risk Inflation is a real risk, and you need to be aware of the inflation rate and how it changes the buying power of the dollars you have in your investments. For example, using the Bureau of Labor Statistics CPI Inflation calculator, $100,000 in 2004 actually had the same buying power as $125,906 today. In other words, you would need another $26,000 to buy the same items in 2016 as you could in 2004. This shows that inflation can be a very real problem, as that was a mere dozen years ago! Interest Rate Risk You also need to keep an eye on the interest rates. They’ve actually been dropping over the past several decades, and this can greatly affect the performance of your investments. Here’s an example that I often use to illustrate this point. If you own a 10-year Treasury bond and the interest rate on that bond rises two percentage points, your principle will lose more than 8% should you sell the bond. Now, if you hold onto it, the bond will mature at face value – although then you will have lost out on opportunity costs! Risk Summarized Do not try to eliminate risk. This is how some investors get into trouble and make bad investments. They meet someone who says you will get an 8% return with no risk, that you can have the market upside return but no downside risk, or that an investment is guaranteed. Even if a few of these statements are found to be true, you still have to face one or all three of these risks: • • •

Market risk Inflation risk Interest rate risk

Do not try to eliminate risk. Try to understand it, and manage it!


Chapter 7 D

The Investor’s Triangle

uring my time as both an investor and as a financial advisor, I’ve discovered that there are three principles that can help improve an investor’s opportunity for success. Those three principles – the three points of the triangle – are: • • •

Knowledge Confidence Discipline

Being knowledgeable about a subject instills confidence, and confidence will drive discipline. Let’s take a quick look at each of these in turn. Knowledge If you want to be successful investor, one key element has to be knowledge, and you need to be willing to keep acquiring knowledge. Keep in mind that having knowledge does not mean you need to become an expert at investing. It simply means that you need to have a basic understanding of what you are investing in and the risks and rewards associated with your investments. You also have to be willing to take the necessary time to continue to stay up on your investments on a regular basis, (such as a quarterly review with your advisor). Some investors seem to either turn all of this responsibility over to their financial advisor, or take all the responsibility themselves. In my opinion, neither is a good strategy. The better strategy is probably something in the 27

middle, which is where investors stay informed, are aware of his or her investments, and follow a disciplined strategy. This takes us to the next corner of the triangle: Confidence. Confidence I’ve found that when people have basic knowledge about their investments and follow a disciplined investment strategy, their confidence starts to grow. The reason confidence is so important when it comes to investing is because it the rock you can stand on…the foundation that allow you to stick to the investment plan when the market corrects, to not overly worry about your investments, and to keep you from chasing the next great investment idea. Confidence does not mean you will not have anxious moments. When the market is going through a correction, it is natural to feel anxious. However, the combination of knowing what you are invested in, and knowing that you have a disciplined investment strategy that has worked well over time, will provide you with a great deal of certainty and build your confidence to stick with the plan. Discipline Finally, you need to have discipline when it comes to your investments. One of the best tools I have found to help with this is to have an investment plan that you implement and stay with. An investment plan is also called an Investment Policy Statement (IPS). An IPS is a simple outline of what and how much you are going to put into different investments based on your risk tolerance. It creates a plan you are going to follow until you change it. And although this sounds ridiculously simple, it is a strategic way to create discipline when it comes to investing. That’s it! These are not necessarily steps you go through in some order. They are more a combination of activities, to-dos, and outcomes. They are three simple principles that I have found many successful investors follow…the three points of the triangle – Knowledge, Confidence, and Discipline. 28

Conclusion N

ow that we’ve come to the end of the book, I truly hope that you’ve learned a few of the strategies, principles, and concepts that I have used during my 30 years in the financial services industry. I’m still learning every day. I’ve enjoyed decades as an investor and an advisor, and I can tell you with confidence that investing is part science and part art. I have tried to share a little of both in this book. I know you’ll find the rewards that come from investing wisely are much more than financial. If you would like to ask me a question or two, feel free to email me at timothy.clif[email protected] Let’s LinkIn too: Timothy Clifford CFP® My goal is to help people invest. Even better.


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