Achieving Financial Success

Financial advisers meeting with potential clients are commonly asked these two questions.

1. What financial products (stocks, bonds, mutual funds) should I buy?

2. When is the best time to buy or sell a particular financial product?

While these are important questions, there are other more important questions that clients should be able to answer for themselves first, such as:

1. What are my long-term goals?

2. What is my time frame?

3. How liquid do my assets need to be?

Decisions about what to buy (security selection) and when to buy or sell it (market timing) should come much later in the financial planning and portfolio management process.

But how can that be true? Every year Wall Street institutions spend millions of dollars promoting the concept that they are better than anyone else at security selection and market timing, because of their:

1. Mountains of research

2. Years of experience

3. Newest computer technology

It is true that every year someone is the best at security selection, picking more “winners” than anyone else the previous year. But history shows that there is little persistence in their ability to pick the next superstar stock or the next mega mutual fund year after year after year. In fact, it is far more likely that last year’s #1 picker will be #5,000 or worse next year.

The same is true about trying to time the ups and downs of the market. In a perfect world we want our financial adviser to tell us when a particular financial product is at its lowest point so we can buy, buy, and buy. And then we want to know when that product reaches its zenith, so we can sell, sell, and sell. That way we can make more profit, profit, profit. And, like each year’s superstar stock picker, someone is the best at market timing every year. Unfortunately, it is usually a different someone every year. Again, no consistency, no persistence.

A Quick Test

Take a minute for a little test. What percent does each of the following play in determining the long-term success a typical investment portfolio?

Security Selection ___%

Market Timing ___%

Portfolio Diversification ___%

Total = 100%

The answer?

Security selection accounts for about 4%, and market timing for another 6%, while 90% depends on the diversification of assets within the portfolio.

In other words, it’s not important which eggs you put in the basket, or when you buy or sell the eggs. In fact, it’s not about the eggs at all. What really counts is how many different kinds of baskets you put yours eggs in.

A significant volume of scientific research has shown that it is the right mix of asset classes (baskets) in an investment portfolio that ultimately determines how much risk, and ultimately how much reward, there is for the investor. That is what diversification is all about. Unfortunately many investors do not understand the concept of diversification.

It all comes down to a matter of greed. There are those who believe more (highest possible return on your investments) is better. The problem with more is that it comes with higher risk. A financial adviser who is a fiduciary (required to put your best interest first) would recommend a portfolio that earns enough to accomplish your long-term goals. Not more, not less. Enough is enough. To determine how much is enough, clients should go though a comprehensive financial plan with their adviser, the end result of which should be to determine just how much return on investments is enough to accomplish any long-term goals. And the best choice to help you determine how much is enough is a fee-only, Registered Investment Advisor.

There is a national organization of fee-only financial advisers that can provide you a list of their members in your area. NAPFA, the National Association of Personal Financial Advisers, can be reached online at their website.

See our next article in this 6-part series: No need to fear alternative investments with new regulations, and proper due diligence.Tom Orecchio, CFA, CFP, CLU, ChFC, AIF, is the President of Modero Wealth Management, a fee-only wealth management service.