When speaking to various groups about pursuing Mastery Of Money, I inevitably get the question, “I have some funds to invest. Where should I put it?”
The question is a hotbed of what ifs, if thens, and how much, not to mention the fact that we haven’t talked about your investment horizon, your risk tolerance, your debt levels, and what you are ultimately investing for.
The easiest answer, and one we’re hearing from the authors and experts at various financial trade pubs (Kiplinger, Smart Money, Money) is Index Funds and ETFs. An index fund maps the overall basket of companies within one industry or sector and you’re investing in that total sector going up or down. It’s a super simple way of investing, and you’re not betting on one company over another so much as investing in the growth of the industry as a whole.
The Value Investing fans out there (like Phil Town, a devoted student of Warren Buffett) would tell you that you should be holding cash on the sidelines in high markets like we’re in and wait for the value stocks. Value Investing was first pioneered by Benjamin Graham in his book The Intelligent Investor. Graham’s concept was buy companies based on the intrinsic value of the company and when the stock is less than the intrinsic value, you buy. The challenge with value investing today in a very bullish market is there aren’t a lot of values to be found.
And the conventional advisors would probably default to telling you that if you have a longer timeframe in which to invest and consider yourself somewhat aggressive, you should probably have 80% of your investable assets in equities and the remaining 20% in bonds. The equities could be individual stocks or mutual funds, groups of stocks managed as one fund.
Digging Deeper Into The Market
A wealth management firm I work with regularly shared some interesting tidbits of information that forever changed my mindset around investing. Specifically as it relates to allocating your investments and understanding how correlation should impact your decision.
According to Bloomberg.com, “in 1986, the number of mutual funds listed passed the number of stocks on the New York Stock Exchange. In 1998, it surpassed the number of overall domestic listed stocks.” What that means is that no matter what mutual funds you’re invested in, there’s a high likelihood that the same stocks are probably showing up in many of them.
Here’s why: the size of the New York Stock Exchange numbers around 1,900 individual companies. It comprises about $25T worth of wealth. According to Business Insider, in February 2017, the S&P surpassed $20T. That means that there are 500 stocks that make up 80% of the overall market’s value. If you think your mutual funds are diverse, you’re fooling yourself.
Correlation Matters
Now, here’s where the “properly diversified” argument fails when invested in equities alone. If you were to look at the overall performance of a variety of mutual funds over time, mapping them all on top of one another, you’d likely see the same dips and peaks across each one at exactly the same times.
The reason why: CORRELATION.
Equities, by and large, have a high degree of correlation. When one moves, the others move. And when invested in funds that have an 80% or higher degree of correlation with one another, you are not properly diversified as it relates to risk. Now, you may have name or industry diversification, but the overall exposure to risk is similar.
If you’re holding a whole bunch of mutual funds and little else, be prepared when the market correction eventually happens. They’re all going to be moving in a similar direction. When the market dips, they all dip.
UNLESS, you come to the same realization that unless you have a mix of equities, bonds AND alternatives, you are not properly diversified.
Where Can I Find Some Alternatives?
Broadly defined, alternatives are considered anything not stocks, bonds or cash. An alternative investment could be anything from precious metals like gold or silver, to real estate, to collectibles. (My neighbor, Rick, has about 10 cars including a Shelby Cobra he bought the week before Carroll Shelby died).
The logic behind investing in alternatives is based on correlation. When stocks are performing poorly, alternatives like precious metals often rise. As of the writing of this post, the spot price of silver is about $16 an ounce. It was $47 an ounce in 2011 shortly after a market correction. You can buy precious metals from places like www.Apmex.com and www.ScottsdaleSilver.com.
If you’re considering investing in things like real estate, raw land, precious metals or collectibles, do so with the full understanding that you’re investing in things that may not be as liquid as more traditional investments. They often serve as a hedge against risk, or, in the case of some real estate investments, might generate monthly returns in addition to increasing in value.
The Bottom Line
If you’re in the asset and wealth accumulation phase of your life, consider evaluating where those assets are sitting using a tool like Personal Capital. If you’re lean on one category or another, depending on your risk tolerance, age, future planning needs, etc. consider adding something that isn’t correlated to your investment mix.
And if you’re looking for an incredible group of people to follow, learn from, and potentially invest with, check out the TS Prosperity Group. They’re wicked smaht.
