- Posted May 13, 2016
If It Sounds to Good to be True…
It surprises me that even after Madoff, and so many other situations where people were taken advantage of, there are still so many people out there who believe they have found the “secret formula” to beat the market and get rich. I think we all know at least one person who attests to their investing prowess and how they’ve uncovered the perfect place to put their money for HUGE returns.
Let’s explore the logic of that for a moment. Hypothetically we’ll agree they’ve found the “secret formula”. How long do you think it will be a secret? And once it becomes common knowledge and more people invest in it, do you think it will continue to stay on top? No, and here’s why. Demand will drive the price up, wise investors will see the price going up and cash out. As they start to sell, others will jump on the bandwagon afraid they’re missing something. Next thing you know it’s a frenzy and what once was an AMAZING investment has now bottomed out costing those who wait too long everything.
Yes – this is a dramatic exaggeration, but it’s exactly what happens with bubbles – be it in the stock market or housing. Markets are efficient – they are going to balance themselves out. If there is a demand, then supply will increase until an equilibrium has been reached; the opposite is just as true – if there is more supply than demand then those providing the supply will decrease production until equilibrium is achieved.
If you know somebody who is claiming uncharacteristic returns in the market, perhaps they got lucky – it happens. But the only proven way to make money when investing is over time, using an asset allocation appropriate for your risk tolerance. This means don’t put all your money into stocks if you’re going to watch what the markets do and pull out when they have a correction (not if, when). Diversify your portfolio – if you’re not sure how to do this work with a professional.
Yes – professionals cost money; but if you don’t know what you’re doing or you’re relying on what your neighbor/best friend/some guy on a subway then you will likely cost yourself much more than a professional will charge. If you want to do it yourself, authors like Rick Ferri wrote some great books on Asset Allocation and Index Funds – do your homework. Most importantly, have a strategy. This will help you weather storms and stay the course. Be realistic with what type of return you want from your portfolio, and take the time to determine what type of return you actually need to meet your goals.
In closing – nothing has changed. If something seems to good to be true, it probably is. In the investment world, like everywhere else – you cannot get something for nothing. It takes time, patience and discipline to develop any type of wealth – if saving was as easy as spending the term “1 percenters” would refer to the poor. But there really isn’t a magic formula – spend less than you make, live within your means and start saving as early as possible.