In my May column, I started a list of "Best Practices" that I learned from my career on Wall Street to guide you and your retirement savings. Here's a refresher:
Diversification is the single most important concept to understand before building a portfolio of investments. Investopedia defines diversification as "a risk management technique that mixes a wide variety of investments within a portfolio." Implementing this strategy allows an investor to achieve higher returns with less risk. We referred to this benefit as a "free lunch". Employing a passive versus active investment management approach is another best practice. Instead of buying individual stocks or bonds (active), passively investing can keep costs down and lead to better long-term performance.
Here are this month's tips for achieving improved investment outcomes:
Low expenses
There are two expenses you must consider when a professional manages your savings. The first is the fee you pay directly to your advisor for their advice; the second is the fee you pay a money manager to make investment decisions with your money. Typically, advisor fees are expressed as a percentage of the portfolio value, or alternatively, charged through commissions. While there are pros and cons to each arrangement, there is, generally, less room for abuse when you are charged a percentage fee. In a commission-based arrangement, there is always the risk that the advisor acts in their best interest, not yours, and transacts purely to generate a commission for themselves. It's perfectly acceptable to ask your advisor if they are acting as a fiduciary (the highest standard of service) or just making suitable recommendationsin your best interests. Regardless of how the advisor is paid, their job is to guide you toward reaching your investment goals.
The outside manager is where costs can turn murky. This is particularly relevant when it comes to mutual funds, a favored investment vehicle used by advisors for many of their clients. If you own a mutual fund, then you are probably familiar with the thicker-than-a-novel prospectus that accompanies the purchase. And don't expect a clear section that details expenses. The investment management world, unfortunately, does an outstanding job of hiding its fees. Whether they are called front-end loads or 12 B-1 fees, they are just industry jargon with price tags attached. Your mutual fund could cost even more than your advisor's fees. This is why Warren Buffet praises low-cost index funds: they spare you hidden fees.
Consider this math: Two investors start with $1 million dollars in savings. They both achieve the same 6% annual return on their investment. One chose an advisor (1.0% fee) who used low-cost index funds charging 0.25% per year, a total of 1.25% per year, the low-cost example below. The other turned to an advisor (1.0% fee) who then uses a highly recommended mutual fund manager (1.25% fee) to manage their money, a total fee of 2.75% per year, referred to as "high-cost" in the example to follow. Over the following time periods, here is what happened:
- 10-years: low-cost $1,579,573; high-cost $1,428,176; additional money in your pocket $151,397
- 20-years: low-cost $2,495,050; high-cost $2,039,686; additional money in your pocket $455,364
- 30-years: low-cost $3,941,113; high-cost $2,913,030; additional money in your pocket $1,028,084
Conclusion? Fees matter. You should do everything you can to minimize them. Think about your Center's repairs and maintenance. Would you ever consider locking yourself into what could be a lifetime of overpaying for what is essentially a commodity product?
Rebalancing
A portfolio should reflect the risk tolerance of its owner. Advisors will work with you to ensure that, or you can do it on your own. In either case, once you have assembled your diversified portfolio of low-cost investments, there is little left to do but wait. Only under certain circumstances will you need to rebalance. Check your portfolio for changes no more often than every three or four months. In fact, we would suggest as little as one time per year.
The reality behind diversification is that some asset prices will go up while others go down, resulting in a portfolio that is no longer properly diversified, possibly too risky, or maybe even too conservative. One of the hardest psychological investment challenges is selling your investment winners and buying more of your losers. But by rebalancing in this way, you bring your portfolio weightings back to your original asset allocation. The corollary to bowling would be systematically building your open play business at the expense of league bowling. This summer, Starlite Lanes will host just one unsanctioned summer league, but open play promotions will grow dramatically.
Another reason for changing your mix of investments is a change in your time horizon, or when you'll need access to your savings. Most typically, as we age and approach retirement, we need to be more conservative with our savings. Simply put, there is less time left to build back portfolio losses. Rebalancing with more bonds and cash equivalents will protect an investor from the risk of market declines as they enter this period of their lives.
Time in the Market
The longer you invest in the market, the more you will earn. Over time, patience and inaction are rewarded. Here at Starlite Lanes, we are celebrating our sixth year in the Kids Bowl Free program. When Bowling Business Builders International initially presented the idea, I was skeptical. Why would we give away our core product for free? Wouldn't that diminish its perceived value? Wouldn't revenues suffer? Still, I gave the program a chance. And while things did start slowly, they built up substantially over time. Today, not only does the program generate great revenue through ancillary sales, but it has also been a foundation for growth in other areas of our business, especially our youth league participation rates.
Unfortunately, individuals aren't geared to stick around and wait for results. Instead, they feel like they need to "do something" to achieve superior outcomes. That's a real risk when market returns are often concentrated and achieved over short periods of time. Missing a few days or weeks of positive returns because of impatience can set an investor back permanently. Think about it; how many famous market timers can you name? None? How about long-term investors? Warren Buffet, Peter Lynch—you get the idea. Whether it is bowling or investing, great investments take time and patience to reach fruition. Jumping from one to another, misses the opportunity to grow something special.
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