So, what stops people from succeeding in investing? Fear? Lack of knowledge? Wrong mindset? Overconfidence? In my experience its usually a combination of these things. Certainly, at various times its been that way for me.
The Biggest Roadblocks
If I was going to focus on my two biggest roadblocks I would say it’s been a combination of overconfidence and a lack of knowledge. In one sense, you could say that one problem led to the other. The specific knowledge that I lacked was in the application of investment principles to my own personal situation.
However, I had studied investing for many years. Also, I had worked for many years in the investing profession. As a result, I thought that I knew everything I needed to know about investing.
Well I didn’t.
Overconfidence
This is a common problem with investment professionals. They believe that they are much cleverer than they really are. I see them make the same classic investment mistakes (or much much worse!) than so-called “normal people”. For example, I have known people to put nearly all their money in one single high-risk investment that they don’t understand.
A classic mistake that I see repeated over and over is people investing directly in the industry that they work in. Or even worse, they invest in the company that they work for! Why is this a problem? Well what happens if your employer goes bust? You lose your wealth and your job at the same time!
Think this is not likely to happen? Think that you know your company? Well so did the super clever bankers at Lehman Brothers. When Lehman Brothers went down those guys were literally suicidal. Imagine losing everything that you’ve worked for in one day!
Don’t Invest in the Industry You Work In!
A less serious mistake would be investing in the same industry that you work in. I worked in real estate investment for many years. Some of the guys I worked with decided to buy properties and apply their knowledge for their own personal use. This is completely understandable but still not a good idea.
If the real estate industry crashes (and it does do this all too frequently), you could lose your job. At the same time the value of your investment properties will plummet. On top of that, if you borrowed to buy those properties you may not be able to repay the mortgage. Especially if you lose your tenants (known to happen). So, then the bank takes your properties and you lose all of your investment. Quite a depressing thought.
Now I appreciate that in the latter scenario a lot of things have to go wrong for you to lose everything. But why put yourself in that situation? Why open yourself up to risk unnecessarily? Ironically one of the guys I know in that situation is a risk analyst…
… being a professional just means that you’re more likely to make bigger mistakes.
The point is, it may feel like investing is for the professionals and small people like you are left behind because you don’t know the ins and outs to make your money work for you. However, as far as I’m concerned being a professional just means that you’re more likely to make bigger mistakes.
In my experience, most people are too afraid of losing their money to make crazy investments like the professionals. So actually, that fear is a healthy thing. You just don’t want to let it dominate your decision making.
Lack of Knowledge
This is another serious roadblock that stops people from investing. Not knowing where to invest your money for the best return possible. Where can you put small sums of savings that will grow faster than inflation? Most people don’t know where to go or who to ask about where you can put your money.
In spite of my education and investing, I suffered from this problem. Sure, I knew better than the average person. I understood how investment worked. But I did not have a framework against which I could evaluate my investments.
Baffled Bankers
And it was the same with the other bankers that I worked with. When I asked them what they were investing their pension in, they looked at me and shrugged. I found this baffling. In most cases, the company that you work for will contribute to your pension. Its part of your compensation and you work hard for it.
House Money
Unfortunately, many people don’t look at it this way. They perhaps see it as house money. The house money effect is essentially viewing profits from an investment as expendable. So, for example, take an investor who has just made $10,000 from a bond portfolio. Maybe he then decides to invest this profit in his friend’s new business. Because it’s a profit and not his original investment he feels more confidence about taking greater risks with this money
The new business goes bust and the investor loses three quarters of his investment – $7,500. However, he still considers himself up $2,500 so all is well. Gamblers tend to view their results this way.
But take the same investor and say that he actually loses $7,500 from the original bond portfolio. This is instead of the $10,000 gain. He’s probably going to feel worse than in the first example. But in each case, he has actually lost the same amount of money.
Are Pensions Free Money?
So, with respect to those banker’s pensions. They are actually viewing that contribution from the company as free money. They are seeing it as a bonus. Even if that were so, you would still want to invest it as responsibly as if it came directly from your salary.
Instead they are treating it as house money. If they lose it it’s not a big deal. Except that it is. I’ve known situations where the company pays you 10% of your salary as a pension contribution. If your salary is $100,000 per year that’s an extra $10,000 per year. It pays to invest that money wisely.
One Size Fits No One
Now you can let the pension provider put your money in some default fund. But in my experience, this particular fund is a one size fits all solution that fits no one. It is not designed for your personal situation. Generally, I found that the returns are significantly lower than what you can achieve if you do a little bit of homework.
Imagine that you are earning 4% on the default fund and 7% on your personalized fund. That is a 3% difference. What happens if we compound that 3% difference over say 20 years? Well a 4% return on an annual $10,000 contribution, after 20 years will accumulate to just below $300,000. But at 7% you will have about $410,000. That’s a difference of $110,000. Is that something you want to just throw away? I wouldn’t.
And that doesn’t even cover any voluntary contributions you are making. You could be giving away 100s of thousands of dollars. And also, in my experience, the default portfolio has higher fees. More money that you could be giving away.
The Knowledge Problem is Universal
My point is here being that the knowledge problem is fairly universal. Experienced bankers know how to invest the banks’ money. But they have no idea how to invest their own. So, you shouldn’t feel bad if you don’t know either. But you are doing something about it now so you should feel proud of that. Simply by reading these articles you are enhancing your knowledge. You are moving closer to that life that you deserve.
But how do you solve the problem of this lack of knowledge? Well I am going address it in detail in this series of articles. So, read on.
The oldest and strongest emotion of mankind is fear, and the oldest and strongest kind of fear is fear of the unknown…
Now maybe your personal roadblock is fear. This is probably the most common problem people face when it comes to investing. It is closely linked to lack of knowledge. Fear of the unknown is a fundamental human trait. As horror writer H.P. Lovecraft said “The oldest and strongest emotion of mankind is fear, and the oldest and strongest kind of fear is fear of the unknown”.
Fear Can Be Rational or Irrational.
Probably in early evolutionary humans this fear was perfectly rational. An early hunter gatherer might practice extra caution when entering a thick forest. He could not see if dangerous animals might be nearby. Or if he came across an unfamiliar animal he might not know if it was a threat.
This kind of healthy fear kept our ancestors alive. But today, letting fear guide our investment decisions can really hurt us! We may rationalize it and consider that we are avoiding major losses. But actually, this fear is resulting in major losses!
Fear Can Cause Huge Losses!
How is this so? Well what I have found is that many of my clients find this fear paralyzing. They avoid the stock market for example and keep their money in savings accounts. This is instead of looking for investments that can help them reach their goals.
So how bad can this be? Is this fear keeping your money safe or is it causing you lose money? Well, consider one of my clients, Matt. Matt’s goal was to accumulate $3m by retirement. He was 30 years away from retirement. He also had $400,000 in savings which is pretty good. Unfortunately, all of this money was in a savings account. I say unfortunately, because contrary to popular belief, your money is not safe in savings accounts.
Banks Are Inherently Unstable
In part this is because of the inherently unstable nature of modern banks. For example, during the Eighties in the United States a quarter of the nation’s 4000 Savings and Loans banks failed. Fortunately, no depositors lost money. The Federal Government stepped in and bailed out the industry at a cost of $150bn!
More recently we have the example of the global financial crisis of 2008. In the United Kingdom for example, four banks failed. These banks collectively held 26% of the nation’s deposits. This time the British government bailed these banks out and saved depositors’ funds.
Aren’t My Savings Guaranteed by the State?
You may now think that your savings are implicitly guaranteed by the State. Not at the Bank of Cypress. During the same global crisis depositors at this bank lost 47.5% of their savings above $132,000. Most people saving for retirement will need much more than this. This “solution” was imposed upon Cypress depositors by that bastion of freedom, the EU.
Now imagine you are about to retire and a crisis hits. And then it turns out that the bank that you’ve put your savings has made too many high-risk loans. Now maybe the State will step in and bail out your bank completely. Maybe this time the State decides that you need to make a contribution to this bail out (as in the case of the Bank of Cypress. Or maybe after so many massive bail-outs the State cannot afford any more. And so this time, the State decides that your bank is not too big to fail (as happened with Lehman Brothers).
In later articles I will explore the reasons why banks are so risky and why they frequently fail. But keep in mind that this is only one of the problems of saving your money in bank accounts. The other is the pitifully low interest rate. Usually, once you correct for inflation your interest rate is negative!
What will this do your retirement plans?
Savings Accounts Can Cost $100s of Thousands!
Well now I return to my client Matt. The best savings rate we found was a 2% certificate of deposit at a bank. Well long term average inflation in the United States is 3.22%.
This effectively means that Matt was earning minus 1.22% on his savings! What would this do to his retirement portfolio?
- Assuming a nominal interest rate (i.e. the advertised rate of 2%) and;
- With an annual contribution of $100,000
- Then in 30 years time, Matt’s retirement portfolio would be $4.8m
If we adjust for inflation:
- In real terms (inflation adjusted) Matt’s retirement portfolio is $2.8m
- In real terms he would have a shortfall of $200k!
If Matt was able to invest at least the rate of inflation (3.22%)
- then Matt’s retirement portfolio would be $6m
- Matt’s loss due to inflation (compared to the first portfolio) therefore is $1.2m!
This should illustrate to you why letting your fear guide your investment decisions is very dangerous to your financial health. In this case, Matt has avoided what he thought was dangerous (stocks) and walked straight into the trap of bank savings accounts.
What is the Solution?
Firstly, he is facing the risk that his bank could collapse taking some or all of his savings. Secondly, he is virtually guaranteeing losses of $1.2m! Fear is a serious problem for many of us. This is exacerbated by the poor rates we receive at banks. To get better rates we can wind up getting locked into subpar solutions like Certificates of Deposits and/or pensions (where you can’t easily access your money when you need it). And for those of us with kids the problems and worry are magnified.
The solution is knowledge. Knowledge of how to invest and how to invest. I’m going to get into this solution in my next article. But if you can’t wait until then, reach out to me. But before you do, If you take a minute to tell me a little bit about your situation I’ll be able to point you to the best possible free resource for you.
Until next time.
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