Wednesday, March 6, 2013

Idolatry in the Financial Markets

A lot of investors, it would appear, are throwing money at increasingly esoteric investments in order to prevent inflation from eroding their capital.  Junk bonds, asset-backed securities and real estate investment trusts have become fashionable.  With the Fed waging a 24/7 scorched earth campaign against positive interest rates, risk is being embraced.  One can only hope that the end result isn't like embracing a cobra--"risk on" investing strategies aren't risk-free.

A false premise widely circulated by financial sales people and cable TV pundits is that you have to preserve your savings from the ravages of inflation.  And, certainly, over long periods of time, inflation can significantly diminish your capital.  But you can't overlook the costs and risks of trying to protect yourself from inflation.  If those risks smack down your net worth, you haven't accomplished anything except lose money and then suffer inflation's death of a thousand cuts.  There's nothing wrong with losing a little ground now and then to inflation, while saving and investing with a view to long term financial equanimity.  If you lose ground to inflation for one, two or even a few years, don't panic.  Try to position your portfolio so that you can make up the "losses" later on.  Also spend less and save more.  This will increase your net worth without requiring you to dial up the risk.

The same is true of keeping pace with market averages.  The Dow Jones Industrial Average, the S&P 500, or whatever benchmark you might follow may be convenient ways to assess the performance of money managers who want to take your savings.  But market indices don't need to be your financial goals.  If your portfolio is conservatively deployed and doesn't keep pace with the S&P 500, you haven't "lost" unless you decide you're a loser.  As long as you are saving enough for retirement, your kids' college costs, and whatever other goals you might have, it doesn't matter a rat's left ear whether or not your investment returns match one market index or another.  If your portfolio is more cautiously invested than the stocks found in an index, you won't suffer the volatility of the index.  Maybe the Dow just reached a record level (although this really isn't a record once you factor in inflation).  But looking back at what happened in 2000 and 2007 after the Dow previously reached record levels will tell you that keeping up with market indices can be a losing proposition. 

Keeping pace with inflation and with market averages are, for individual investors, false idols that they need not worship.  Building your net worth isn't a contest.  It's a process.  There are lots of ways to make your retirement years golden.  Do whatever helps you sleep at night.

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