Its not the fees.
Its not even the portfolio churning manager.
Its not the financial adviser.
The biggest enemy of your investments is YOU.
I realized this with my own behavior. With more passion to manage investments and as I learn more, I started to tinker my portfolio almost every month, if possible every week coming up with a new plan.
Selling stocks and bonds, reallocating in the name of asset allocation, refinancing mortgages, buying exotic investments – all are detrimental to peace of mind, and moreover to the productivity of those little bundles of money sent to work for you.
Each investment needs time to grow. Except for hard cash, when you invest in something it needs to stay there to do its job. Equities and Real Estate are long term investments and bond and bond funds are medium term. But none is a short term get rich scheme.
So what makes us do this damaging exercise? The economy around us is constantly changing and producing a lot of noise. We dance to its tune and the sense of a smart ME, does not let us ignore the noise of the experts.
- For example, the last few months the mortgage interest rate went down and down, and there was huge rush for refinancing mortgages. Hopefully all the refinancing makes sense in terms of cost and long term goals. It is perfectly fine to just not do anything if your mortgage is already in the low 4% or even lower.
- Similarly, the news and predictions about an impending stock market crash is making a lot of investors shaky and market pundits elated at the same time. Equities are long term investments and there is no need of any action for a crash. The markets are cyclical and any equity investment should be part of a long term (> 15 years) portfolio.
- Real Estate similarly is at an all time high, with REIT returns touching new highs and homes selling for record prices. This may well be time to be cautious and investors should not change anything in their Real Estate allocation, but just wait out the present jubilation. Or simply continue buying REITs at regular intervals like equity with a longer time (20 years) horizon.
- I have also seen people switching their cash from one bank to another just to capture the extra 0.2% interest rate, or get that $300 bonus for opening a new account. A $300 free money does sound alluring, but read the fine prints of the terms and conditions. You have to setup a direct deposit and also deposit a lump sum of new money into the account and hold it for 90 days to get that $300. All this will cause huge changes in your financial plan and system. And then once you get the $300, what next? Another bank may offer $400, but are you going to change your direct deposits again, and move the surplus money which could have been invested?
- Simply for changing your asset allocation, selling stocks and funds can incur a huge tax bill, if the capital gains and taxation are not taken into account. For example, short term capital gains are taxed as ordinary income than long term. So even though the asset allocation looks skewed than what you want, it is better to tweak your monthly investments to slowly adjust the portfolio towards desired asset allocation.
As an illustration, below is my asset allocation now and what I want it 5-7 years later.
Note that since I moved from India, a major allocation is still Emerging Market stocks, mostly in Indian stock market. I am also holding about 18% in cash, which needs to be redeployed.
The simple way to achieve this is to freeze the Emerging Markets and Cash allocation, and for next few years my investments will be heavily tilted towards US and International (developed market) stocks and bonds.
As I reflect on the 2019 year to date, I have been victim to this behavior of myself. Following are some of the tinkering I did, which left me with little tangible benefits but probably valuable lessons.
- I refinanced a 3.625% mortgage (7-1 ARM going into 8.6% on 8th year) into a 4.125% fixed rate mortgage. The rationale was that a fixed rate mortgage will make cash flow predictable. Hence if I rent out my house few years from now, I will not be hit by increasing interest rate scenario. However with recent low in interest rate, I lost an opportunity to refinance at a fixed rate even lower than the ARM.
- I hired a financial adviser to suggest mutual funds across all my portfolios (401k, taxable etc.) and paid him $500 for two sessions. At the end, as I learnt more I ended up choosing my own investments, although a part still came from his recommendation.
- I bought a 5 year locked home warranty, possibly not so useful in the long run. I have used them only once in last year, and most of the expensive repairs they don’t cover anyways. I could have done better to save the money instead.
- I accumulated a decent amount of cash and procrastinated to invest it. In fact it was a decision on which I vacillated between buying real estate or investing in equities. I did nothing and it just sat there in a savings account, earning less than 2%. At the end of the year, now I have the urge (or somewhat a need) to buy a second car. This money had it been invested earlier, would have forced me to think more creatively on how to acquire the second car. I don’t like car loans, so probably I will now use this cash to buy the second car, a depreciating asset.
So sometimes action is good and inaction is bad.
At other times, too much action should be avoided since long term investments need the long (really long) term to perform. Here inaction is the best way forward.