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Grow Rich Slowly

Naturally, many investors would like to find the right investment or investments that would propel them into prosperity as quickly as possible. Toward this end, some often seek out individual stocks, or alternatively, aggressive fund choices, often investing a high percentage of their overall portfolio where they expect it will have the best chance to appreciate rapidly.

Of course, such creation of quick wealth can occur, but realistically, only for a tiny percent of investors. However, since it always remains a possibility, some investors still will hew closely to strategies they hope will propel them into affluence in a matter of several years as opposed to the prospect of, at best, having to waiting for possibly several decades.

Even if the typical investor tones down somewhat this fast-paced attempt to race for the top, the objective of many investors remains one of striving to always shoot to maximize returns at all possible times. But strategies to maximize returns often mean maximizing one's level of risk as opposed to accepting the possibility of somewhat lower returns in order to keep potential portfolio-dampening returns, including negative ones, to a minimum.

More simply put, and especially apropos to today's investing environment, investors might be tempted to opt for maintaining large bets on investments that have "shot the lights out" over the last 5 or 6 years. Examples would be funds heavily weighted in healthcare or technology related shares (or even the S&P 500 index which currently has over one-third of its investments in these two sectors), vs. spreading out investments more broadly, to include other less currently well-performing areas.

Recent results seem so clearly stacked in favor of the current above-mentioned types of funds as to make appear "a dinosaur" anyone who hasn't ridden such winners. In fact, the mouth-watering gains might seem so "natural" right now that they could easily be regarded as a no-brainer. And for those who remain in what once appeared to be promising market segments that have recently underperformed, it may be increasingly hard to "stay the course."

Over the last year alone, Vanguard Health Care (VGHCX) has returned nearly 30% (through 6-26); Fidelity Select IT Services Portfolio (FBSOX) (technology sector) has returned over 23%. (And over five years, owning both could have nearly tripled your investment.) These funds are largely made up of Growth stocks. By contrast, some of the bigger funds investing primarily in Value stocks, such as Vanguard Value ETF (VTV) and American Funds American Mutual A (AMRMX), are returning on the order of 7% over the last 12 months. Can it be that investors in the former funds are that much smarter than those who invested in the latter funds? It certainly might appear that way.

Of course, many investors who invested in a similarly aggressive fashion eventually learned the negative side of always gunning for high returns year after year. The bear markets of 2000-2002 and late 2007 through early 2009 showed just how much one can suffer when continuing to stick with the best performing types of funds when their reign finally topples. Yet still, now over 6 years into the current bull market, some may be tempted to assume that, yes indeed, you should be able to get rich perhaps easily and somewhat quickly by aiming for constant high returns regardless of the build-up of risk that comes after years of outsized returns.

Here's my main point which not everyone will agree with, since it is more of an opinion than a provable fact: Believing overtly, or even on a subconscious level, that investing should be about aiming for uninterrupted wealth-producing gains is a strategy that can lead to "feast or famine."

Stories abounded over the last decade and a half about people who amassed large amounts of investment gains only to lose much or all of it when the markets changed direction. If you want to almost guarantee that nothing like that will ever happen to you, especially the older you get since you will have less time to recover from severe losses, consider the alternative: Be willing to accept and actually work toward a somewhat slower and safer build-up of wealth.

For most investors, you can obtain wealth far more reliably by seeking out and settling for more modest gains, while at the same time, avoiding risky choices that can easily wipe out most or all your overall yearly or even multi-year gains.

Back in 2003 and in early 2009, when stock prices were relatively low, it might have made sense to have had high expectations for stocks, although of course, the risks were still there. While the future, as always, remains unclear, it appears that it may not be that long before many of the most money-producing investments of recent years will certainly have more downside risk and less upside potential. Adopting an investing strategy that nearly always features the same aggressive assumptions year after year may work; but, likely, only provided that today's winning choices will remain so continuously.

So, let me succinctly re-state the alternate strategy to attempting to get rich quickly: Get rich slowly!

The history of successful investing has shown that your chances of acquiring considerable wealth are actually quite good, if

a) you "settle" for a well-diversified portfolio that permits you to neutralize occasional loses with either offsetting gains, or at least less severe losses, and

b) you allow enough time for moderate gains to grow down through the years into much larger sums that you can expect to enjoy later in life or at least leave to your heirs.

Most investors have some difficulty in following each of these above conditions, a) and b). Let's see why.

Most people have various forms of biases that disincline them from putting together a well-diversified portfolio consisting of various types of both stocks and bonds. I define a bias here as a belief that while it may have some element of truth, prevents a person from fully utilizing the money-generating capacities, as well as wealth-protecting features, of an asset class. Here are just a few examples:

  • "Stocks are far better investments than bonds so why should I invest in bonds?"
  • "Stocks are much too risky; look at how they performed in 2000-2002 and during the financial crisis. I can't expose my savings to these kinds of risks."
  • "Bonds are always safer than stocks."
  • "Bull markets or not, stocks haven't performed very well over the last 15 years. Remember some of the best performing stock funds back in 2000? Some of them haven't even returned 3% a year since then. I don't think the average person should bother with stocks."
  • "I don't understand bonds; I've heard you always lose money when interest rates go up."
  • "Experts really have no agreement which stock or bond funds are best so I'll just invest in a basic index fund such as one investing in the S&P 500 or a bond market index fund."

As a result of such biases, and many more, vast numbers of investors tend to heavily focus their investments on only certain types of investments. Many often omit important categories of stocks, such as international, value, or small cap funds, or stocks or bonds altogether.

When things are going as expected for the sometimes limited number of categories of funds they have chosen, investors can relax and enjoy their profits. But when things inevitably start to go bad, these investors, often caught by surprise, tend to sell these funds after some (or even a great deal) of the profits made in these investments are lost.

As stated above, investors in more diversified portfolios often find that such losses are offset by either smaller losses or even gains in other parts of their portfolio. And such stutter-step patterns of gains and losses make it easier for them to occasionally refocus their portfolios, or alternatively, to "rebalance," in the hopes of earning better returns going forward.

In short, better diversification, while perhaps somewhat limiting your gains in up markets, usually enables you to potentially do better in down markets. And why shouldn't you trade some loss of potential gains when, over time, the markets' rewards are sufficient that you don't need to always go for the highest returns? Just earning, say, 9 to 10% on average on your stock returns, and 4 to 4.5% on your bonds over the years, should actually enable you to become quite wealthy in as few as 20 years or so, assuming of course you do not manage to spend all of your gains along the way.

And what about condition b), that is, continuing to invest over a long enough period to allow your gains to grow? While some people do this, in my estimation, many, many people do not. Rather, many succumb to either the fear of losses or to temptation to pull out after achieving only a fraction of potential gains.

So if you are under 55 years old, you should have still have plenty of time to steadily and reliably accumulate wealth ahead of you without resorting to high-risk investing. But what if you are over 55? By settling for moderate gains, instead of always aiming for the biggest ones, your investments should still grow nicely, with a much reduced chance of one or two really bad investment years cutting into the amounts you will almost surely need to comfortably prosper in your advanced years.

As I have frequently pointed out, both the stock and bond markets and the pundits who expound on them, almost regularly seem to send out dire signals suggesting that the bottom is about to fall out. Experience suggests to me that in well over the majority of instances, these warnings are off-base. In fact, often, when the economic news looks particularly awful for an asset category (take, for example, the troubles in the eurozone or bonds right now), the subsequent outcome turns out far less dire than expected.

During such numerous instances, investors should carefully weigh the risks and rewards involved in staying invested in an asset category, or alternatively, switching to a less "threatened" category, when necessary, rather than pulling out of their investments altogether. The majority of such moves, if made at all, should be small and gradual to protect against these predictions of scary scenarios that never wind up happening, or our own often incorrect interpretations of the economic and investment tea leaves, that also never happen, or even if they do, often have consequences that are all but eradicated within days or perhaps weeks.

 

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