TWELVE LESSONS FOR BOOMERS ABOUT INVESTING LEARNED THE HARD WAY

Let me say upfront, I am not a financial planner, I am a Boomer who became a consumer of financial services out of necessity. After much research and study I concluded that no one will look after my finances more diligently than me. The same applies to you. Admittedly I have made some good calls and some really, really stupid ones. But then, so has Warren Buffett as he admitted in his recent address to shareholders of Berkshire Hathaway. We’re all going to make mistakes. The smart ones amongst learn from them, so should you. So, quit beating yourself up if you’ve screwed up. With this collective "Mea Culpa" out of the way, here are twelve lessons about investing that I Iearned the hard way that hold true in good times and bad. Hope they help you as much as they helped me

Rule # 1: Be Thou Ever So Humble

In 1999 my portfolio outperformed the indexes by a very healthy margin. I felt like a master of the universe. The following year my portfolio went into free fall and crashed. I was crushed. The internet bubble burst and I wondered if I’d recover my ego as well as the money I lost. As a first step in my recovery I read every thing I could get my hands on about investing and portfolio management. I realized that when you make money in the market you’re never as good as you think you are and when you lose money you’re never as stupid as you think you are. The fact of the matter is that eight out of ten stocks follow the market. When the market goes up so do they, and vice versa. So be humble and never lose sight of this fact of investment life.

Rule #2: You Will Lose Money in the Market

If everyone was guaranteed they would make money in the market Las Vegas would go out of business. Once you decide to buy stocks expect to lose money at some point. When this happens don’t panic and pull out. Stay the course because over the long term you will make money in the market. The challenge is to manage your emotions. To put things in perspective your return from 1970 through 2007, according to Fund Advice.com, had you invested only in stocks you would have realized a gain of 13.7% but lost money in seven of those years. The loses we are experiencing now are unprecedented in our lifetime. No one expected it. To keep things in perspective, however, if the market can lose half its value in six months it can regain it in six months.

Rule #3: Take the Long Term View

It is very difficult to avoid constantly checking the market thanks to the proliferation of cable channels offering financial news including second by second tick of the major indexes. I have to constantly remind myself that I am a long term investor not a day trader and daily market fluctuations whether to the upside or downside should have little or no impact on my state of well-being. Put it this way, I have to be more like Warren Buffet and less like Jim Cramer. So must you if you are to avoid becoming addicted to financial porn. Most experts still agree that the stock market will grow close to a healthy eight percent over the long term which means stocks will outperform all other securities including bonds and money market funds. So, if you want to avoid getting an ulcer turn off the financial cable channels and watch Oprah or Dr. Phil. You’ll sleep better!

Rule #5: With Reward Comes Risk

I know every investor understands that with reward comes risk. But here goes any way. Risk and reward is the relationship between possible risk and possible reward which holds for a particular situation. To realize greater reward one must generally accept a greater risk, and vice versa. This is referred to as the risk/return tradeoff. From an investment perspective this means that when we chase higher returns for example, purchasing an emerging market mutual fund that has produced historically high returns, we have to prepare ourselves for greater risk on the downside. In other words, the greater the projected return the higher the risk.

Rule #6: Pay Attention to Asset Allocation

Studies show that 90% of a portfolio’s return is determined by the mix of stock, bonds, cash equivalents. Broadly speaking it also includes real estate, precious metals and other investment categories. The underlying rationale for asset allocation is to balance risk and reward because different asset classes behave quite differently. For example, when stocks go up, bonds typically go down. More significant, bonds are more stable than stocks but not as financially rewarding. The lower the ratio of equities to fixed income the lower the return and the lower the volatility. If you are not sure how much to put in fixed income follow John Bartle’s advice, he’s the founder of Vanguard Investments and the father of index funds, and allocate an amount equal to your age. For example, if you are 65 allocate 65% to fixed income securities and 35% to equities.

Rule #7: Choose Index Funds Over Managed Funds

Over the long term index funds are safer and outperform managed funds. Did you know that in any given year only 25% of managed funds outperform the market? There is no guarantee that a fund that beats the index will replicate the feat the following year. Yet the average expense ratio for managed funds is 1.5% of the funds assets. This is charged regardless of its annual return. In contrast the typical fee for an index fund is around .25%. Vanguard’s S&P 500 Fund has a fee of only .18%. Adding to the cost of managed funds is their annual turnover, put at around 95% which drives up annual transaction costs. Taking this into account, over the long term index funds which mirror a given market, e.g., S&P 500, emerging market, international value, and US small cap funds will out perform, have lower risk and be less expensive than managed funds.

Rule #8: Create a Balanced Portfolio

Once I was sold on index funds and asset allocation I developed a balanced portfolio consisting of 60% equities and 40% fixed income. I split equities 50-50 between US and international funds. Then, within each I further diversified equities between small and large cap and between growth and value funds. In this manner, I had a portfolio that gave me growth while simultaneously lessening some of the down side risk inherent in investing for the long term. That being said, my portfolio declined in 2008 and is not doing so hot this year. In the last twelve months it has declined 25% which is gut wrenching but it would have been at least twice as bad had I not created a balanced portfolio.

Rule #9: Don’t Try to Time the Market

In an ideal world we’d love to know when the market is going up and when it is going down so we can determine when its time to buy or sell. There are traders who use technical analysis who claim they can predict when the price of individual stocks will rise and fall. Others say predicting the rise and fall of stocks is a crap shoot at best. The evidence suggests that buying shares in first rate companies or buying a diversified basket of index funds and holding on to them for the long term is the best approach. The reason is, the market is unpredictable. The big question we are facing now is knowing when the bottom of the bear market will be reached. The answer is impossible to predict. We do know that bear market bottoms are often followed by swift recoveries. If you get out and stayed out of the market while it it's going down chances are you will miss the first few days of the upturn and not recover some of the ground you lost. Again, no one knows the direction of the market so if you can avoid a swift pull out you may be better off staying put.

Rule #10: The Past Won't Predict the Future

When I began investing I chased returns by looking for the hot stocks and hot funds touted by the many financial publications and websites catering to the amateur investor. I remember funds exclaiming they beat the Lipper or Morningstar or some other benchmark for the previous 12 months. These funds are just as likely to under perform the next year. In 2007 Standard and Poor’s found that over a five year period mutual funds that outperformed their benchmark index often failed to repeat their performance the following year. Another study found that random chance played as big a role as any factor, e.g. fund manager’s experience, fund family, in determining their ability to outperform their relevant benchmark! So pay very little attention to past performance. But, if you must you are better of looking at a longer horizon of five or even ten years.

Rule #11: Don’t Play With House Money

Gamblers love to play with house money. I’m referring to another type of house money, the money you need to keep in ready cash to pay for annual living expenses. I believe it makes sense to keep three years living expenses out of the market during this traumatic time. I did. When the market starts its recovery it will be tempting to leverage as many dollars as you can to recoup from steep losses. Try not to. Keep money you will need to pay for necessities including food, clothing and shelter in reserve. If you are in your Second Half have a bigger cushion than if you were employed. Err on the conservative side.

Rule #12: There is No Free Lunch

The final lesson I Iearned is one of the first laws of economics is, there is no free lunch. Everything has a price, nothing is free. I remind my children of this whenever I can. My son told me he was given a free PC by his college at the beginning of his freshman year. I used his comment as a teaching moment advising him that I was quite sure his $45,000 tuition bill included the price of his “free” PC. Nothing is free, and if something seems free look for the back door entrance through which you are being charged. For example, a redemption fee if you purchase a no load mutual fund.

As I was writing this post it occurred to me that someone may suggest there is only one investing lesson DON'T! At the risk of sounding Pollyannaish, although these are tough times we will come out of it bigger, better and stronger. I believe this deeply. After all, aren’t we the most entrepreneurial, productive, innovative and hard working nation on the face of this earth? That’s the main reason for investing in the market in the first place even though it is a stomach turning time for all of us. So put on your helmet, tighten your chinstrap, tie your laces and hitch up your pants and get in the game because there are better days ahead.