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FINANCIAL PLANNING |
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PERSPECTIVES |
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What is
the real reason you should invest?
| January 2005 |
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Most people think they know the answer to the question
of why should they invest. Yet many all too often invest for
the wrong reasons—and that can lead to financial
difficulties.
Most investors assume that the goal of investing is to
simply earn the highest return possible without losing
money. If they’re investing in common stocks, they assume
they should earn at least 10 to 11 percent every year
because that’s roughly the long-term average for stocks. But
often they’re not satisfied unless they exceed that by
earning 20 or 30 percent or, heck, doubling the return on
their investment.
But wise financial planners will tell you that earning the
highest possible return should not be the real goal of
investing. Rather, the main purpose of investing is—in
conjunction with other components of your financial life—to
help you realize major life goals: a comfortable retirement,
a dream job or business, a college education for your
children, funding for your favorite charities, or
accumulating assets to pass on to your heirs.
What’s the difference between these two approaches to
investing, you may wonder. What’s wrong with double-digit
returns? Won’t they accomplish those life goals? Nothing’s
wrong with consistently earning double-digit returns. It’s
nice work if you can get it.
The problem with shooting for the highest return possible as
the main goal in investing is that it can create unnecessary
risks and erratic investing patterns that ultimately
undermine efforts to achieve those life goals that truly
matter to you.
Most financial planners have war stories about clients, or
more often, prospective clients, who come to their office
expecting that the planner’s primary job is to earn them fat
returns on their investments—to beat the market. When these
planners respond that they can’t design a sound investment
strategy until they understand the person’s goals and the
other aspects of their financial circumstances, these
prospective clients often leave and head for the next
financial advisor, until they find one who promises them
glorious returns.
How can investing solely for the highest returns create
unnecessary investment risk and erratic investing patterns?
Holding unrealistic return expectations. A California
CERTIFIED FINANCIAL PLANNER™ practitioner recalls being
fired by a client during the height of the booming late
1990s stock market because though the client’s portfolio was
doing very well, and was more than accomplishing the
client’s goals, it wasn’t earning the 100 percent annual
return the client thought it should be earning. The ensuing
bear market harshly demonstrated to that former client and
many other exuberant investors that high double-digit
returns of the 1990s were not a given.
Taking unnecessary risks. Much of the riskiest
investing, overbuying, and panic selling during the late
1990s and early 2000s would have been avoided if individual
investors had created their own investment plan for
achieving long-term specific goals such as retirement or a
college education. For example, investors who can reach an
investment goal by earning a modest average annual return
are less apt to jump into higher-risk investments than those
with no plan except to always “go for the highest return.”
Investors shooting for the highest returns also are more
vulnerable to investment scams offering returns that “are
too good to be true.”
Not taking enough risk. After risking all for the
highest returns during the good times, many investors who
got burned bailed out of the stock market and are now afraid
to invest at all. Some have even stopped contributing to
their company-sponsored retirement plans.
Again, they’ve lost sight of the real purpose of investing.
The result is that they not only panicked and cashed in
their losses, they shifted their entire portfolios to
low-yielding savings accounts and money markets. While these
vehicles can serve useful financial purposes, holding an
entire portfolio in them hinders efforts to achieve
long-term financial goals.
Failing to diversify. Shooting solely for the highest
returns tempts investors to chase and overload in the
current hot part of the market, and ignore underperforming
sections. When large-cap and high-tech stocks stumbled in
2000–2002, stock-heavy investors weren’t situated to take
advantage of the previously ignored real estate investment
trusts (REITs), bonds, commodities, and even gold, all of
which had banner-return years.
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(This column is produced by the Financial Planning Association, the
membership organization for the financial planning community, and is
provided by Fredrick J. Livingston, CFP®, Planmark Capital
Management, LLC and he is a Registered Principal with, and offers
securities through, Linsco/Private Ledger, Member NASD/SIPC.)
The opinions voiced in this material are for general information
only and are not intended to provide specific advice or
recommendations for any individual. To determine which investment(s)
may be appropriate for you, consult with your attorney, accountant,
financial advisor, or tax advisor prior to investing.
All performance referenced is historical. All indexes are unmanaged
and cannot be invested into directly.
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