There are many ways to make a fortune. You might inherit money, win the lottery or build a thriving business and sell it. You can also work hard in your career, save and invest with discipline. Making a fortune often includes elements of risk and luck. Inheriting money is a form of luck. Working for a company like Apple and receiving incentive stock options includes both risk and luck. Investing in a hot stock like Amazon at the right time includes risk and luck.
Amazon is the most recent example of a white-hot stock. If you invested $10,000 in July 2002 and held it to December 2017, it would be worth about $838,000. That’s a return of over 8,000%!
Recent research by Hendrick Bessembinder, a finance professor at Arizona State University, found that only 4% of all publicly held stocks that have ever existed in the U.S. account for all the market’s net gains from 1926 through 2015. That’s only 4 out of every 100 stocks. Wow. The winners are all names you would recognize: Exxon, Mobil, Apple, GE, Amazon, etc. This might lead you to believe that picking stocks is the way to go. But, the research further revealed that 58% (about three in five) of individual stocks have performed worse than one-month Treasury bills over their lifetimes.
Another recent study by Ned Davis Research, Inc. looked at the S&P 500 index over the past 45 years. It discovered that the one company with the largest market value in a given year went on to consistently underperform the index in future years. The cumulative deficit for owning that largest stock, instead of the broader index, was a lag of 8,000%, coincidentally the same as Amazon’s positive return above. The company today with the largest market value is Apple.
Risk exposes itself most often in the forms of volatility and uncertainty. Typically, the higher the risk, the higher the reward, and vice versa. For many, stress is a side effect of risk. Once you have your fortune, why have a high-risk strategy that adds more uncertainty and additional stress to your future? It seems preferable to have an optimal combination of risk and reward. Just enough risk to provide the necessary level of reward to meet your needs and goals.
The iPhone had its 10-year anniversary last year and Space-X landed and then reused a rocket booster for the first time. Human gene editing is now a reality. Think about the rise and fall of companies in the past like Blockbuster, Kodak, AOL, and Nokia. The initial dominant company isn’t always the survivor. Are you willing to bet your fortune on which auto company will dominate the industry in 10 or 20 years once electric cars, self-driving cars, and ride sharing become common? Will Tesla and Uber survive, thrive, or dive? Changes in the auto industry are likely to ripple through other industries as well. Today most shopping malls and many retail stores in the US are undergoing a swift decline or repurposing because Amazon and internet shopping have rendered them less desirable.
The speed of change is undoubtedly accelerating. Not only do you have to avoid losers and pick today’s winners, you must pick tomorrow’s winners too. It’s likely there will be more Amazons that seem to come from nowhere – until they are everywhere.
Now That You Have Your Fortune, How Do You Preserve It?
Remember those three out of five low-performing stocks in the research above? The good news is that the other two out of every five stocks made up for the underperformers. Altogether, the total U.S. market, as measured by the CRSP 1-10 index, returned 9.8% annually. That return is almost triple the return of T- bills at 3.4%, and more than triple the value of inflation at 2.9%, for that same period from 1926 to 2015.
There’s more good news. Most references to portfolio performance are based on the classic portfolio consisting of U.S. large stocks and U.S. bonds. But, more recent studies demonstrate an improved return from a globally-diversified portfolio, without any measurable increase in risk.
Bad markets are inevitable. You can minimize, but not eliminate, certain kinds of risk. You will dilute or destroy your market reward if you don’t make it through a downturn. Your downturn plan quantifies how you will survive. It stress-tests your portfolio in bad markets. You get a sense of how much rebalancing you can do to take advantage of a down market.
Once you make a bad decision in a down market, it is unlikely you can ever get that money back. Instead you’ll be forced to change your spending or the wealth to your heirs will be diminished. A downturn plan can make the difference between long-term success and permanent failure.
Your portfolio needs to sustain spending for the rest of your life. Every portfolio allocation has an expected return and sustainable range of spending. Matching allocation and sustainable spending is crucial. There’s an enduring myth that your equity allocation should be equal to 100 minus your age. Ignore that myth and instead, address factors like risk tolerance, downturn survival, spending goals, tax impact, inflation, time horizon and desired terminal wealth to arrive at the allocation that suits your needs.
There are a multitude of critical financial issues that must be addressed on an ongoing basis such as: tax law changes, tax opportunities in retirement, the impact of IRA distributions, when to take Social Security, the need to update important legal and estate documents, maintaining beneficiary designations, properly titling assets, and whether you still need life insurance, just to name a few. Successful preservation of a fortune is not just about portfolio management, but also about making good financial decisions over a lifetime.
What is RCG’s Role as Your Professional Wealth Advisor?
Knowledge about harnessing the stock market continues to evolve, thanks to ongoing academic studies and the power of today’s computers. New investment strategies are continually being introduced. RCG stays informed and discerns which opportunities can be expected to add value in all or most market environments and which ones are just data mining strategies that happened to thrive over the past 10 years.
Rather than rebalance only quarterly, we have software programs to do the rote math so portfolios can be evaluated weekly. Areas of imbalance in the portfolio are identified and the advisor then applies judgment and awareness of the client’s unique situation to make trading decisions. Trading typically should still be done only four to seven times a year, but at optimum times, rather than just at a quarter end.
If you still need help appreciating the value of a fiduciary, we recommend two recent articles written by Jason Zweig, a columnist for the Wall Street Journal. The 19 Questions to Ask Your Financial Adviser and its follow-up, The Special Trick to Find the Right Financial Adviser, offer an easy-to-read and insightful look into the benefits of working with a fiduciary.
We have experience, tools, and knowledge, and have spent our careers addressing financial decisions. We know we can add value and (we hope) peace of mind. It’s true there are great low-cost investment funds out there that anyone can use. But knowing which ones and how to use them makes all the difference. And, there are all those other issues highlighted above about allocation, a downturn plan, sustainable spending, and wise financial decisions that could benefit from expert guidance.
You might be willing to stare down risk to make your fortune. But, consider that: “What got you here, won’t necessarily get you there.” Once you have your fortune in hand, do you really want to take more risk than you need to?
An oft-quoted maxim is, “Don’t put all your eggs in one basket.” While this is generally prudent advice and supports investment diversification, some investors believe it’s wise to have more than one investment consultant.