Pete1
12-12-2005, 12:20 AM
I would highly recommend that everyone check out Jonathan Clements' column in the Wall Street Journal. Here is his latest:
Five Bits of Conventional Wisdom to Ignore
By JONATHAN CLEMENTS
Staff Reporter of THE WALL STREET JOURNAL
Question everything.
The longer I write this column, the less faith I have in conventional financial wisdom.
We all rely on rules of thumb and generally accepted notions because we don't have time to research every financial issue and probe every assumption. Life is just way too short.
Yet conventional financial wisdom often doesn't stand up to close scrutiny. Here are five ideas I have tossed out in recent years.
1. Money Pit
Many folks say their home is the best investment they ever made. That may indeed be true, thanks to the extraordinary tax advantages of owning your own home and the forced savings that come with those monthly mortgage payments.
But if homes are a great investment, they aren't an investment in the conventional sense. To understand why, ask yourself one simple question: If this pile of bricks is such a financial bonanza, where's the cash?
As with many investments, your home's return comes in two parts, price appreciation and income. If you live in your own home, the income takes the form of "imputed rent," the fact that you get to live in the place rent-free.
This imputed rent is enormously valuable. Still, you aren't collecting cash that is fattening your bank account. In fact, every year, money pours out the door, in property taxes, maintenance expenses, homeowner's insurance and mortgage payments.
Similarly, your home's price appreciation probably hasn't put much cash in your pocket. Local property sales may indicate you have made big money.
To cash in on your home's gain, however, you would need to trade down to a less-expensive place. Not many people ever make this move.
Even retirees who "trade down" often end up buying homes that, while smaller, cost just as much as the larger house they left.
2. Counting Down
Like real estate, the financial markets are supposedly one of America's great wealth-creation machines. But I have reluctantly concluded that most investors make little or no money.
Suppose you own a balanced portfolio of stocks and bonds that delivers 6% a year. Subtract two percentage points for investment costs, and you will be down to 4%. Lose 25% of that after-cost gain to taxes, and your return will be 3%. What if inflation comes in at 3%? In real terms, you aren't making any money.
Sure, the numbers look better if you minimize taxes and clamp down on costs. But how many folks really do that?
It isn't just the math that makes me think investors are struggling to make money. It is also the emails I get.
I hear from far too many readers who feel burned by their brokers, or burned by the market, or burned by their own foolishness. Combine these poor investment decisions with the brutal impact of costs, taxes and inflation, and the picture is pretty darn bleak.
3. Fair Game
The more you trade, the more bad decisions you can potentially make. And most people trade way too much. Indeed, every day on Wall Street, millions of investors ask the same question: Is it a buy or is it a sell?
I, too, am constantly chewing over this question. It hasn't got me very far. For instance, I was convinced real-estate investment trusts and bonds would have a rough time in 2004. It didn't happen. So I figured the rough patch would hit in 2005. Yet both sectors again have made money for investors this year.
It's finally dawning on me that, instead of presuming that every market sector is a buy or a sell, it's smarter to assume that everything is fairly valued. Subsequent events will prove this assumption to be ridiculous, as some sectors skyrocket while others plummet.
But because picking winners and losers is so difficult, it's more sensible to assume that current market prices aren't that out of whack with underlying values -- and that you should neither overdose on a sector nor avoid it entirely.
4. Commitment Counts
I used to agonize over what percentage of a portfolio should be allocated to, say, emerging-market stocks, or high-yield junk bonds, or large U.S. companies. But now, whenever somebody asks me how much to allocate to a particular sector, I usually respond that -- within reason -- it doesn't much matter.
Yeah, this takes some explaining. If you tap into a broad market segment using a well-diversified mutual fund, you can be pretty confident that you will make decent money over 30 years. Moreover, over those 30 years, there probably won't be a radical difference in performance between, say, U.S. stocks and foreign stocks, or between, say, intermediate-term government bonds and intermediate-term corporate bonds.
With that in mind, you shouldn't fret too much over your precise allocation to large stocks, small stocks, foreign stocks, REITs, corporate bonds, government bonds and other market sectors. Instead, what counts is commitment.
In other words, whether you allocate 15% or 30% of your stock portfolio to foreign markets probably won't make a whole heap of difference over the next 30 years -- provided you stick with your target percentage. The danger: You get greedy or fearful, trade in and out of your foreign funds and end up missing out on the sector's handsome long-run gains.
5. Standing Pat
Conventional wisdom says that as you age, you should shift toward bonds and tilt your stocks toward established dividend-paying companies. I used to agree with this notion. I don't anymore.
Who says we grow more risk-averse as we age? True, retirees should have a decent amount in bonds.
But by the time folks quit the work force, they often have years of investment experience under their belts, so they are less rattled by stock-market turmoil. Result: You could imagine a nervous 30-year-old who keeps 60% in stocks -- and a veteran 70-year-old who is comfortable with the same allocation.
Similarly, I don't think retirees should shift into blue-chip stocks, because they will end up heavily invested in one sector. Granted, these stocks have a reputation for safety. But if blue-chip stocks suffer a rotten 10-year run, retirees will dearly wish they had opted for true safety -- by spreading their portfolios across a much broader array of stocks. (end).
Bottom line: stay the course with a long-term, diversifed portfolio divided between equities and fixed income.Don'ttrade your portfolio. Take what the market freely gives. The most important long-term investment decision is how much you allocate to stocks and fixed income for the long-term. This singledecision has more to do with your long-term return than the individual funds that you select or your acumen and presciencein terms ofshiftingfrom stocksto fixed income.
Five Bits of Conventional Wisdom to Ignore
By JONATHAN CLEMENTS
Staff Reporter of THE WALL STREET JOURNAL
Question everything.
The longer I write this column, the less faith I have in conventional financial wisdom.
We all rely on rules of thumb and generally accepted notions because we don't have time to research every financial issue and probe every assumption. Life is just way too short.
Yet conventional financial wisdom often doesn't stand up to close scrutiny. Here are five ideas I have tossed out in recent years.
1. Money Pit
Many folks say their home is the best investment they ever made. That may indeed be true, thanks to the extraordinary tax advantages of owning your own home and the forced savings that come with those monthly mortgage payments.
But if homes are a great investment, they aren't an investment in the conventional sense. To understand why, ask yourself one simple question: If this pile of bricks is such a financial bonanza, where's the cash?
As with many investments, your home's return comes in two parts, price appreciation and income. If you live in your own home, the income takes the form of "imputed rent," the fact that you get to live in the place rent-free.
This imputed rent is enormously valuable. Still, you aren't collecting cash that is fattening your bank account. In fact, every year, money pours out the door, in property taxes, maintenance expenses, homeowner's insurance and mortgage payments.
Similarly, your home's price appreciation probably hasn't put much cash in your pocket. Local property sales may indicate you have made big money.
To cash in on your home's gain, however, you would need to trade down to a less-expensive place. Not many people ever make this move.
Even retirees who "trade down" often end up buying homes that, while smaller, cost just as much as the larger house they left.
2. Counting Down
Like real estate, the financial markets are supposedly one of America's great wealth-creation machines. But I have reluctantly concluded that most investors make little or no money.
Suppose you own a balanced portfolio of stocks and bonds that delivers 6% a year. Subtract two percentage points for investment costs, and you will be down to 4%. Lose 25% of that after-cost gain to taxes, and your return will be 3%. What if inflation comes in at 3%? In real terms, you aren't making any money.
Sure, the numbers look better if you minimize taxes and clamp down on costs. But how many folks really do that?
It isn't just the math that makes me think investors are struggling to make money. It is also the emails I get.
I hear from far too many readers who feel burned by their brokers, or burned by the market, or burned by their own foolishness. Combine these poor investment decisions with the brutal impact of costs, taxes and inflation, and the picture is pretty darn bleak.
3. Fair Game
The more you trade, the more bad decisions you can potentially make. And most people trade way too much. Indeed, every day on Wall Street, millions of investors ask the same question: Is it a buy or is it a sell?
I, too, am constantly chewing over this question. It hasn't got me very far. For instance, I was convinced real-estate investment trusts and bonds would have a rough time in 2004. It didn't happen. So I figured the rough patch would hit in 2005. Yet both sectors again have made money for investors this year.
It's finally dawning on me that, instead of presuming that every market sector is a buy or a sell, it's smarter to assume that everything is fairly valued. Subsequent events will prove this assumption to be ridiculous, as some sectors skyrocket while others plummet.
But because picking winners and losers is so difficult, it's more sensible to assume that current market prices aren't that out of whack with underlying values -- and that you should neither overdose on a sector nor avoid it entirely.
4. Commitment Counts
I used to agonize over what percentage of a portfolio should be allocated to, say, emerging-market stocks, or high-yield junk bonds, or large U.S. companies. But now, whenever somebody asks me how much to allocate to a particular sector, I usually respond that -- within reason -- it doesn't much matter.
Yeah, this takes some explaining. If you tap into a broad market segment using a well-diversified mutual fund, you can be pretty confident that you will make decent money over 30 years. Moreover, over those 30 years, there probably won't be a radical difference in performance between, say, U.S. stocks and foreign stocks, or between, say, intermediate-term government bonds and intermediate-term corporate bonds.
With that in mind, you shouldn't fret too much over your precise allocation to large stocks, small stocks, foreign stocks, REITs, corporate bonds, government bonds and other market sectors. Instead, what counts is commitment.
In other words, whether you allocate 15% or 30% of your stock portfolio to foreign markets probably won't make a whole heap of difference over the next 30 years -- provided you stick with your target percentage. The danger: You get greedy or fearful, trade in and out of your foreign funds and end up missing out on the sector's handsome long-run gains.
5. Standing Pat
Conventional wisdom says that as you age, you should shift toward bonds and tilt your stocks toward established dividend-paying companies. I used to agree with this notion. I don't anymore.
Who says we grow more risk-averse as we age? True, retirees should have a decent amount in bonds.
But by the time folks quit the work force, they often have years of investment experience under their belts, so they are less rattled by stock-market turmoil. Result: You could imagine a nervous 30-year-old who keeps 60% in stocks -- and a veteran 70-year-old who is comfortable with the same allocation.
Similarly, I don't think retirees should shift into blue-chip stocks, because they will end up heavily invested in one sector. Granted, these stocks have a reputation for safety. But if blue-chip stocks suffer a rotten 10-year run, retirees will dearly wish they had opted for true safety -- by spreading their portfolios across a much broader array of stocks. (end).
Bottom line: stay the course with a long-term, diversifed portfolio divided between equities and fixed income.Don'ttrade your portfolio. Take what the market freely gives. The most important long-term investment decision is how much you allocate to stocks and fixed income for the long-term. This singledecision has more to do with your long-term return than the individual funds that you select or your acumen and presciencein terms ofshiftingfrom stocksto fixed income.