This past month the financial advisors at Ruedi Wealth Management wrote five more “Investing 101” columns for The News-Gazette’s Business Extra Section geared towards beginner investors. Make sure to look for the columns every Sunday, but in case you missed any of the columns from May all five are below.
Too Smart to Make Investing Mistakes?
Paul R. Ruedi, CFP®
The name Sir Isaac Newton is almost synonymous with vast intelligence. As a genius physicist and mathematician he had a profound impact on our understanding of the world. You would be tempted to think this intelligence would have translated to an equally genius investing career, but this is actually far from the case. In his paper Newton’s Financial Misadventures in the South Sea Bubble, Professor Andrew Odlyzko of the University of Minnesota School of Mathematics looks at the historical record of Newton’s investing decisions. As the title of the paper implies, things didn’t go particularly well for Sir Isaac.
Newton, like a lot of smart and wealthy people at the time, experienced a wild ride investing in the hot stock of the day: a global trading company called the South Sea Company. To be fair, Newton invested in the company back in 1712, long before the company’s stock price saw explosive growth in 1920 and increased roughly 5-fold in just a matter of months amongst a sea of investor enthusiasm. He even sold most of his shares at that time and made a very hefty profit.
Had Newton had the discipline to just walk away and enjoy his profits, we would be telling a very different story today. But after Newton sold his shares the price of South Seas Company stock doubled in two weeks. The fear of missing out overcame Newton and in a panic he bought back in at twice the price he had recently sold his shares for. When the price rose another 8% instead of taking his winnings, he bought even more.
Like many companies whose stock prices experience a rapid rise in a short time due to investor euphoria, the price of South Seas Company stock eventually crashed and took Newton’s investment portfolio with it. Odlyzko suggests his losses were as high as 70%. He remained a wealthy man, but only because he was wealthy before investing.
The whole ordeal affected Newton profoundly. He supposedly could not bear to hear about it for the rest of his life. It famously caused him to say, “I can calculate the motion of heavenly bodies, but not the madness of crowds.” Moral of the story, if even a genius like Sir Isaac Newton can get swept up in an investor mania and fall victim to his own emotions, then clearly no amount of intelligence can guarantee against investing mistakes. If you think you are simply too smart to make a bad investment decision, you should probably think again.
Is Now a Good Time to Invest?
Daniel Ruedi, CFP®
Whenever someone I talk to has a lump sum they need to invest in the stock market I get the same question: “Is now a good time to invest?” People rarely elaborate on what they mean by “good time to invest,” but I know what they are asking. They want a market timing call, some prediction as to whether the market will go up or down over the next period of time. Behind this question is yet another question that gets down to our most basic human emotions: “Is this going to hurt?”
Though nobody can predict the movements of the stock market in advance, the first question is one that can be answered with data. Since the stock market goes up over time, in any given period you are more likely to be happy you invested than not. It is less certain over short periods than long periods, but in both cases your expected return on stock investing is positive.
Answering the second question is more difficult. People often worry about investing right before a big decline and there really isn’t any way around this possibility. Temporary declines occur regularly but there is no way to predict when they will happen in advance. But investors will only regret a temporary decline if they get caught up in the emotional turmoil of the time, panic, and sell their investments. Those who remain invested are eventually treated to a recovery and life goes on.
If investing a lump sum all at once is simply too difficult emotionally, it can be helpful to invest in small pieces over time. For example, a person could invest 10% of their money each month over the next 10 months. This is one situation where what is mathematically optimal can differ from what works for a person emotionally. It is mathematically optimal to put any money that needs to be invested in the stock market immediately. But some people simply can’t handle that and will want to invest the money in small chunks over time to avoid regret if the market tanks.
Investing can be a challenge for many people emotionally. In the worst cases, these emotions prevent people from investing altogether and cause them to miss out on the returns they need to fund their most important financial goals. It is important to remind yourself that if money needs to be invested, it is always a good time to invest. If that is too hard to handle emotionally, make a plan to invest smaller amounts over time and stick to it.
Should I Manage My Own Investments?
Ryan Repko, CFP®
Many people wonder whether it would be better for them to hire a financial advisor to manage their investments or to pursue a do-it-yourself approach. The truth is, many people can successfully manage their investments themselves, making it unnecessary to pay someone to do so. To determine if you are a good candidate to manage your own investments, you should first ask yourself a few questions.
The first question is “do I have the expertise?” A successful investment portfolio needs to be low-cost, globally diversified, and occasionally rebalanced to ensure the appropriate asset allocation based on your goals. With enough research, you may be able to determine what investments you can use to build a portfolio that checks these three boxes. But remember, mistakes are very costly.
The second question is “do I have the discipline?” Everyone thinks they have the discipline to be their own investment manager when things are good. It is easy to be an investor when things are going well. It becomes significantly more difficult to stick with your investments during temporary declines, or long periods of little to no return. Making emotional mistakes at the very worst times can complexly derail your progress towards your goals.
The third question is “do I have the time?” Successful investment management requires time during every part of the investment cycle. On the front end, researching how to invest and manage your portfolio requires a significant amount of time. Between regular adjustments to your investments and staying on top of your required minimum distributions, investment management only becomes more complicated and time consuming as you age.
If you have the expertise, discipline, and time you should be able to manage your own investments. I know many people who successfully manage their own investments, who would consider paying an advisor to be wasteful.
But I often find that completely capable people with the time to manage their own investments choose to hire an advisor to take the burden and the responsibility off their own shoulders. They value paying an advisor to not have to second-guess all the decisions they made (or didn’t make). There is an incredible peace of mind knowing that a trusted, capable professional is watching out for your livelihood, not just your finances, in retirement.
There is no right or wrong choice. The important thing is that your money should be managed by someone with the expertise, discipline, and time to make sure everything is done correctly. Whether that person is yourself or a financial professional is completely up to you.
Do I Have Enough to Invest?
Paul R. Ruedi, CFP®
One of the most common reasons I hear for people putting off investing is that they feel they simply don’t have enough money to invest. In the past, investing generally did require you to have a lot of money. Before stock investing was widely available you literally had to have enough money to buy an entire business. Even with businesses broken into shares that can be more easily purchased in the stock market, sometimes the cost of one share can be in the thousands. For example, a single share of Amazon will cost you over $3,000, so it is no wonder everyday investors get discouraged.
But the investment industry has changed dramatically in the last few decades, providing small investors with more options than ever before. I’d go as far as to say that an investor with as little as $100 can efficiently invest their money. Technically a person could invest even less than this. But I think this is a good starting point because if you can’t pull together $100 to invest, you probably aren’t ready to invest, given your personal financial situation.
It is usually free to open a typical brokerage account – a fancy name for an investment account. Some companies require a small minimum investment, but there are brokerage firms out there with no minimum requirement. So when it comes to having enough money to open an account, $100 will likely more than suffice.
Instead of buying tons of individual stocks, investors can purchase shares of low-cost exchange traded funds (ETFs) – which are basically big investment pools that hold the stock of hundreds or thousands of companies. Shares of these ETFs are often below $100, and may be so low you will be able to buy multiple shares. Most brokerage firms allow you to trade certain diversified low-cost index ETFs for free. That doesn’t sound like a big deal but when you pay a $6-20 transaction cost every time you invest $100, you lose a sizeable percentage of your investment to transaction costs.
The wealthiest people in the world are generally business owners, and today’s investment infrastructure gives small investors the ability to participate in the same type of business ownership that builds wealth over time. By using low-cost ETFs that are free to trade, investors can create a low-cost, diversified portfolio that invests in thousands of companies with very little money. So if you think you don’t have enough money to invest but happen to have an extra $100 hanging around, think again. You can start investing and building your wealth today.
Financial Advice for Small Investors
Daniel Ruedi, CFP®
In the past small investors faced a catch 22: it was very difficult to receive quality financial advice if you weren’t already wealthy! In the past the cost for advisors to serve each individual client was high enough that to talk to a financial advisor you had to have at least $500,000 or even $1 million. This left small investors with little to no options for quality advice.
Fortunately, that has changed over the years. Technological advances have made it so much more efficient for advisors to serve clients that the amount of money a client must have to get quality financial advice has dropped tremendously. In fact, a whole industry of high-tech “robo-advisors” has popped up to provide financial planning and investment management to smaller accounts that typically would not get any attention from a traditional advisor. This technology was later picked up by large brokerage firms and even independent RIAs like Ruedi Wealth Management in order to serve smaller accounts. Where there used to be few options for small investors to receive advice, there are now several high-quality options.
“Robo-advisors,’’ or online-only financial advice platforms really drove this change. By automating many of the processes around account management, they were able to specifically target small or beginner investors. Robo-advisors typically set up an account for you, and invest the money in a diversified portfolio. Some even do some very basic financial planning to make sure your portfolio is aligned with your goals. Many of these robo-advisors have no account minimum and generally charge low management fees around 0.25-0.5%.
Large brokerage companies also adapted the technology to create their own robo-advice platforms or hybrid advice models, where they pair a robo-advice platform with the guidance of a financial advisor. They have low account minimums and they have comparable fees to robo-advisors. Vanguard Personal Advisor Services, for example, has a $3,000 account minimum and charges 0.3% of the assets they manage.
Last but not least, independent RIA firms like Ruedi Wealth Management have adopted robo-advice platforms that enable them to serve smaller clients than they could previously serve before. Firms like this will generally charge traditional financial advisor fees (around 1% of the money they manage) and will treat it as a way to provide comprehensive financial advice to people they couldn’t have served in the past. Ruedi Wealth Management, for example, was able to lower our account minimum to practically 0, and are thrilled to be able to help smaller investors.