Tuesday, November 18, 2008

What Should I Do With My Money?

Turbulent times confuse household investors. I know I'm confused


An interesting and timely experiment was conducted by one of our local business papers. Trying to answer the eternal question of "what should I do with my money?" the paper set out to review what leading brokers, financial planners and money managers would recommend someone with a liquid saving of $50,000.

The question of what to do with our money is always present as money always has an alternative cost (and risk). Since money is a very flexible commodity we are often tempted to explore our options. At times of financial crisis this sort of behavior can be very risky.


What causes household investors to retreat back to the false safety of liquidity?


Not surprisingly, economic downturns cause the vast majority of household investors to retreat quickly, like frightened turtles, into liquid or short term bank deposits instead of exploring other more profitable ventures. I know I do.

I can testify, first hand, on the roots of this behavior:

#1 I worked very hard for this money. It'd be a shame to see it go to waste.

I feel my hard earned money shouldn't be carelessly spent while pursing the dream of fantastic returns. Each crisis is unique and carries surprises of its own. It is rather painful to see my money dwindling with each passing day as stock indices constantly search for new lows.
There are no guarantees in the markets. The Dow at 8,000 is not sacred and past indicators are never really relevant for the future. In the markets, very much like in wars, we are usually fighting the current crisis with the previous crisis' lessons.

I'd much rather sit this crisis out and join back in after a healthy spike in prices (although I'd probably be too scared as well).

#2 The need for a solid and healthy emergency fund has never been so relevant

It seems to me only the financially secure may have the luxury of making money out of this crisis. Personally, I've never been gladder to have my emergency fund as a comfy pillow to fall on should I need one.

Even though I've been able to save a bit more than I'd planned on in my emergency fund I sleep better knowing I've got two more months of living covered.

#3 I can't really commit myself to an appropriate investment term

Who really know when this crisis will end? Chances are we'll see a glimpse of financial hope during the second half of 2009 but who really knows? We can't afford to bet on averages with this crisis.

Furthermore, I've got too much going to really be able to commit to an appropriate investment term in stocks. As I've always written in the past, an investment term shorter than 5 years isn't suitable for a real long-term investment in stocks (preferably longer).

Again, only the financially secure seem to enjoy this luxury.

#4 I'm too greedy

Honestly, I may be just timing the market. I've recently written about a bull trap in the market that proved itself. Maybe next time it won't be a trap but the real deal. For now, I'm greedy.
Why did I call it the false safety of liquidity? As we all should know by now, liquidity is probably the worst long-term investment available. In the end, household investors lose big on their fears. But that doesn't mean those fears are unjust.


What did the brokers have to say?


First and foremost, keep in mind money managers make their living of our investments. As a result, it's always a good time to start a new portfolio.

Second, don't expect to find any answers. Brokers and money managers aren't smarter than us when it comes to timing the market or they would have retired long ago. What they are good at is maintenance.

The "professional" replies split into three distinct types:

1. If you have the discipline and financial depth to watch your portfolio shrink by 50% and wait it out than you can start thinking about buying stocks.

2. Go solid.

3. Some would say this is a good time to buy stock (A redundant and obvious tautology).

All the brokers stated the current price levels are low and seemingly attractive. Yet all of the brokers also stated that volatility and uncertainty are extremely high and that investors should be cautious. Bottom line: You decide, it's your money.

When you think about it brokers, analysts, planners and all other money professionals have no real motivation to be original. If they're original and they're wrong (say bet on a violent up trend when all is lost) they pay dearly. If they go with the herd and they're wrong no one can really blame them.

I do think professional money managers are important. They have the ability to maintain our portfolio and some do have a competitive advantage both in skill and knowledge. However, ultimately, it's up to us as investors to make the right choices, mainly Investment term and risk level.

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6 comments:

San Francisco Financial Planning said...

Lots of good advice above. This is one area where it is important to have a strategic plan. The longer the timeframe until you need the cash, the less change you need to make to a well balanced portfolio. I find that many people panic and make changes they do not need to make. If you can, check in with a financial planner to see if changes acutally need to be made or if you are simply being 'panicked' into unnecessary and possibly dangerous action.

Louisa said...

This was a really great post, thank you for sharing your insights! I am wondering if you can help me - I just started working with this group of IPs out of Germany, the MORE Fund, which is an affiliate of Innoveas AG (www.innoveas.com) and they seem to offer a great alternative investment opportunity. I am hoping you can provide me with some advice about the world of alternative investing. Any help would be appreciated, thank you!

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Kacie said...

If I suddenly found myself with $50k, here's what I'd do:

- Pay off my last debt (a car loan at about $8,300)
- Buy some things for my apartment ($1,000)
- Max out retirement contributions for the year in the 401k and open an IRA
- The rest would go in the best short-term place I could park it. Maybe a high-interest savings account or a CD with a 12-month time period or so. I'd use that for a down payment on a house in a few years.

Kacie said...

I should also mention that those retirement contributions would be placed in a well-balanced mutual fund. No individual stocks for me! I can't handle that kind of risk.

Dorian Wales said...

@Louisa - please email me to discuss.

@Kacie - First of all sounds like you've got your goals in order which is excellent. I would recheck on that solid retirement fund though, a share of stocks is recommended. You don't have to invest in individual stock there are a lot of mutual funds and etf's out there..