Posted: June 12, 2014
How to avoid four investment ogres
A financial fairy taleRon Phillips
A long time ago, far, far away, lived a charming prince. This prince could do no wrong. He was awarded many tributes and much princely treasure. Many townsfolk believed and depended on his charm.
One day his spell wore off and revealed, as if by magic: off-balance-sheet debt, false profits and revenues, accounting scandals and losses. Who is this toad-like entity? The once-mythical Enron Corporation.
OGRE ONE: CHASING WINNERS
I am constantly reminded of this company during our new bull market. The S&P 500 has gone up for five years in a row. It deserves to be at these levels and it will go higher. But to put all of your assets into a recent winner is a recipe for loss.
What we’re experiencing is a “reversion to the mean.” Or something going up that was significantly down. Eventually we’ll reach more normal returns. Then it’ll be time for other asset classes to go up. You want your money in these other, cheaper categories now before they become the new winners. If all of your funds are tied-up into the latest winner then you’re losing other opportunities for growth.
OGRE TWO: FINANCIAL OVER-DEPENDENCE
If you have a company 401k plan, or other tax-deferred plan, you want to avoid company stock. Why?
Enron stock went from about $20 to a high of $90 in a year and a half. This was great performance. Employees who chose stock were sitting pretty. Then, another roughly year and a half later, the stock was at 26 pennies per share. Twenty-six pennies.
Also, of the 20,000 Enron staff eligible for a pension, got a nasty surprise in the form of large Enron stock positions. So both retirement plans could possibly have shrunk to pennies-on-the-dollar.
This is what financial over-dependence on one company looks like.
OGRE THREE: OFF-THE-BOOK FINANCIALS
What did we learn from our mothers? “If it’s too good to be true it probably is.” Enron had gobs of tricky accounting inflating their handsome returns. They were similar to Madoff and his accounting. Both stories had very unhappy endings.
How do you avoid these beastly practices? You don’t entirely. But you can drastically minimize them by buying mutual funds or ETFs. Instead of one stock or bond you buy a basket of securities. When one goes bust then you have dozens, or even hundreds more, to fall back on. What’s the chance of, for example, 428 stocks in a fund going under versus one Enron going under? I’ll bet on the fund.
OGRE FOUR: NOT BEING DIVERSIFIED
This is the twin brother of Ogre One. Loading up on one or two investment categories is a sure way to participate in bubble meltdowns. Whether it’s the Tech Bubble, Gold Bubble, Real Estate Bubble or others, you need to protect your downside. You do that by having many unique investment categories.
Most of these investment ogres have one thing in common: emotional investing. It’s best to take emotion out of your decisions and stick to smart, proven strategies. That way you don’t wind up the damsel in investing distress.
Ron Phillips is an Independent Financial Advisor and a Pueblo, Colorado native. He and his wife are currently raising their two sons in Pueblo. Order a free copy of his book "Investing To Win" by visiting www.RetireIQ.info or leaving a message on his prerecorded voicemail at 924-5070. Simply mention Promo Code #1001 when ordering.