“After all what I’ve been through I just lost faith in the stock market” (Anonymous Investor in El Paso, TX)

After talking with numerous investors about finance and investing, I’ve found that a lot of them are disappointed, frustrated, and even angry at themselves because of what happened with the stock market during the last 18 months. Some of them even feel that “investing is not for them”.

When I ask them “how did you know how to invest?”, some of the most common answers were (not in particular order):

  • ”I followed XYZ (insert TV talking head name here) advice”.
  • ”It’s what friend/coworker/boss are doing”. -”ABC magazine said…”
  • ”My GHI (insert family member here) worked at that company for 20 years”.
  • ”My broker/financial planner/advisor told me that those funds have had great returns”

What does this tell us?

To me, that means that people are making the most important financial decisions based on their  emotions (such as greed and fear) and other people’s opinions; resulting in stress, anxiety, and also on constantly changing their asset allocations in an effort to time the market (and most often than not with the worse timing, but more on that on a later post).

So, if an investor has lost faith in the stock market, how does she recover it?

First of all, I don’t think that the markets are something that you put your faith on. I believe that faith belongs in your heart and in God (whatever your perception of divinity is). What you need to do is to take responsibility on your investments and to know the right things about investing.

What right things?

To start, you need to know why you are investing in the first place (define your true purpose for money), then you need to know what you are doing in your investments, why you’re doing it, how much its costing you and if what you’re doing is consistent with your purpose for money.  If your broker isn’t willing/able to help you to answer these questions, then probably he is part of the problem instead being part of the solution and you need to replace him with someone that can help you them answer those questions. Once you know the answer to those questions, you need to ask yourself: am I paying someone to gamble with my money?

Slot machine.
Slot machines are a place to gamble, your portfolio is not. Image via Wikipedia

A couple of signs of gambling in your portfolio may include, in the case of mutual funds:

  • High turnover ratio (for me, over 30% is high). For example, if your mutual fund has a turnover ratio of 125, it means that it replaces 125% if the stocks on it every year, clearly indicating excessive trading (and all its associated costs), stock picking and market timig.
  • You bought (or were sold) a fund based on the “Lipper rating” or the number of “stars” that Morningstar gave to it. If you do this, you are chasing past performance, and that’s never a guarantee of future returns.

If you’re investing in individual stocks you are not only gambling, but you’re also taking a big (and unnecessary) risk in your portfolio. It is very difficult to have a well diversified portfolio with individual stocks. A well diversified portfolio should include thousands of different stocks and bonds, and the mix should be determined according to your risk tolerance.

Do you know how many stocks/bonds do you have in your portfolio? Unless you purely invest in individual stocks, you probably don’t know it.

In short, your faith belongs in your heart and your God, not on investing. To invest prudently you need to know the right things: define your true purpose for money; understand what you’re doing and why; determine how much it’s costing you; and, eliminate all gambling and speculation in your portfolio. If you have any questions or comments, you may send them over HERE.

This article reflects the views and opinions of Miguel Gomez. Disclaimer.

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