I know I don’t have to tell you that risk management is one of the keys to successful long-term investing.
But here’s the strange thing: most responsible, risk-conscious investors underperform the market—and not by a little.
Because the reality of risk management is not the conventional wisdom frequently peddled by financial advisors. They warn that taking on too much risk will threaten your life savings, so you need to choose an extremely conservative fund and invest for the long term.
That’s close enough to the truth to sound convincing—but unfortunately it’s wrong. (I’ll show you two funds that upend the “conventional” wisdom—and deliver consistent market-beating gains—in just a moment.)
Here’s the real secret to growing wealth by investing: understand the markets, understand the mistakes retail investors make and avoid them.
There are two obvious mistakes: gambling and opting out. You may have a friend who loves to day trade and swears they make a huge profit from it. But then you should ask yourself why they’re still day trading, why they’re still working and why they don’t live near Richard Branson.
Because the reality is, these people aren’t raking it in—they’re gambling—and probably losing a lot of money. But because of pride, they only brag about their wins.
The “opting out” mistake is another familiar, but more boring, one. You probably have co-workers who fear the stock market, so they keep all their money in their house.
There’s just one problem with that—gains from housing are terrible:
A Secure Retirement from Housing? Yeah, Right!
When I talk to friends, family and non-financial professionals about how they plan on using their home equity to secure their retirement, I feel a mix of pity and frustration. Look at that chart! A 540% gain sounds good, but that’s an annual growth rate of 4.2%. Stocks get you an 8.4% return—double that of housing! Betting on your home for your retirement is sheer folly.
Smarter people who understand math realize this and look beyond their homes. But then, there are thousands of funds and many thousands more stocks to choose from. Where does one put the money?
This is where the financial-advisor mistake comes into play.
Many advisors urge conservative allocations with a mix of U.S. Treasuries and stocks. Many also overcharge to help you “balance” your portfolio to allocations that make sense for your age.
Why do I say “overcharge”? Because there are very cheap target funds that do this automatically for you, and usually for much less money. Vanguard has some of the most popular ones, with the lowest fees, making them the best of this product line.
Sadly, the best choice from a selection of bad choices is still bad.