We are now in the three weeks, from the 17th day of Tammuz to the 9th day of Av (i.e. Tisha b’Av), a period of mourning to commemorate the destruction of the Beis HaMikdash. Jews traditionally observe several mourning customs, including refraining from music, weddings, parties, public celebrations, haircuts, shaving, reciting Shecheyanu, and dangerous activities.
I will leave the discourse about the myriads of halachic considerations over these customs to the far more qualified rabbis in our communities. However, I do feel comfortable opining on the minhag of avoiding dangerous activities, within the realm of investing.
There are a variety of dangers associated with investing. After all, if there was no risk, there would be no reward. In fact, an important component of successful investing is to understand the relationship between risk and reward. Taking prudent risks can lead to higher possible returns. Too much risk, though, can put a person’s financial future in jeopardy. Sadly, many families don’t understand how to minimize dangers within their portfolio.
Below I will share some dangers to which an investor’s portfolio is susceptible and how to mitigate them.
- The danger of behavior: Every human is emotionally charged. Some people get emotional about politics, others about certain industries, or a company’s business practices. Your emotions and behavior are one of the biggest risks to your portfolio.
Investors tend to make drastic decisions when they are feeling scared, greedy, or impatient. Unfortunately, these impulsive moves rarely, if ever, work out. Emotional decisions have no place in the world of successful investing. When it comes to emotions, the best approach is to keep them in check. This can be done by automating as much of your investment process as possible.
Dollar-cost averaging is the process of routinely adding money to investments at regular intervals. Automate your investing by implementing a dollar-cost averaging strategy. It’s a seamless way to build wealth over time. As Warren Buffett once said, “Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” Automation can help facilitate that temperament.
- The danger of geopolitics: There are always concerning geopolitical headlines that may impact the value of your investments. War, terrorism, natural disasters, and the way a country’s leadership reacts to these realities, can cause market fluctuations. The best way to mitigate political risks around the world is by always adhering to the principle of diversification. All companies, sectors, and countries go through cycles. When things go south, having an overly concentrated position in any one area of the market can be devastating. The best way to protect your portfolio from this risk of over-concentration in one market segment is to have a policy of diversifying across many asset classes and countries around the world.
- The danger of buying at all-time highs: A big concern in today’s market is that prices are too high. After all, as of this writing, the S&P 500 is up over 16% this year and the NASDAQ is up 19%.
If you are invested in stocks, then you should have a long-time horizon. Over many years and decades, the broad markets will continue to rise and today’s all-time high will no longer seem so expensive.
On the other hand, if you are a short-term investor, keeping your cash in a money market account or short-term bonds is far more prudent. This will allow you to avoid worrying about the markets dropping from their relatively high prices.
The key is understanding your time horizon. Once an investor appreciates when they will need their money, they can invest their funds prudently and not need to worry about the current stock prices.
- The danger of falling interest rates: A recurring discussion point over the past few years has been interest rates and when The Federal Reserve plans to lower them. Folks looking to purchase a home and retirees living on bond-generated income are keenly interested, hoping for the best possible outcome for themselves.
If you are in the market to buy a house, don’t daven every day for lower rates. The reality is, when rates come down (and subsequently mortgage rates drop), housing prices will go up in value. Interest rates and housing prices tend to have an inverse relationship. It’s far better to look for a home you can afford in today’s interest rate environment. This may mean looking at smaller homes or in a different community. Once you are in the real estate market as a homeowner, you can always sell your home in a few years and use that to purchase a new home in a more desirable area. Waiting for an optimal interest rate environment may cause you to wait indefinitely.
For retirees who are concerned that rates will fall, which will cause them to generate lower interest on their bonds, I’d suggest exploring other ways to generate cash from your portfolio. This may include selling stocks that have appreciated in value, incorporating a Single Premium Immediate Annuity, and waiting to claim social security until age 70 to obtain a higher lifetime benefit. Having a portfolio that is entirely dependent on interest rates is a recipe for disaster.
- The danger of higher taxes: Americans are always concerned with a change in tax policy. This may impact one’s take-home pay. It can also be burdensome to business owners and the stock market. As I always tell my clients, don’t let the tax tail wag the investment dog. Tax policy will ebb and flow in different political climates and shouldn’t be the sole driver of your investment decisions. After all, other than voting in politicians who favor lower taxes, the best strategy investors can use to mitigate onerous taxes is to be proactive. This means using tax efficient investments, tax advantaged accounts, and working with your tax professional to do projections and strategize how to minimize taxes in the future.
- The danger of sequence of returns: The concept of “sequence of returns risk,” or the risk of experiencing a string of unfavorable returns as you begin to draw down on your portfolio, is a very difficult scenario from which to recover. A good example of this was during the 2008-2009 Great Financial Crisis. Some soon-to-be retirees had their 401(k) invested much too aggressively or too concentrated in their own company stock. The market downturn and fragility of the financial system was devastating. Instead of retiring as planned, some of these people got wiped out by the market crash and were forced to remain working much longer than originally planned.
One way to manage sequence of returns risk is to set up a “bond tent.” The concept of a bond tent is to keep a few years’ worth of expense money in very short-term high-quality bonds or cash. The remaining assets can be invested, perhaps more aggressively, according to various other goals. Should the market have several years of subpar returns, the investor won’t have to liquidate their more volatile holdings at a steep loss. Rather, they will be able to use their cash cushion or high-quality bonds to meet their expenses as they wait for the market to recover.
- The danger of inflation: Inflation can be defined as a general increase in prices and fall in the purchasing power of money. Inflation is to blame for the cost of a ride on the New York City subway going from only a nickel to almost $3. It is also why having too much money sitting in cash will actually cause you to lose money when factoring in inflation. Even with money market funds and CDs paying an attractive yield, these returns will still underperform the market and over the long-term will also not outperform inflation.
The best way to mitigate the danger of inflation is to invest in stocks. Over time, you will outpace inflation and build your nest egg. Hiding in cash will not allow you to achieve these goals.
The above points should not dissuade you from taking any risk. After all, if you don’t take risks, you won’t grow. The three weeks teach us that there are certain times when dangers should be avoided. This is true regarding your portfolio, business, and life in general. However, if you want to achieve more success and make more money, you need to face your fears and occasionally live dangerously. The act of taking calculated risks makes life much richer.
