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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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The only reason to be aggressive is so you can hold out the hope of higher upside than youll get with conservative investingWe couldnt plan out every day for 30 years, and we didnt try to. Instead, we moved the goal post in manageable chunks of time, looking out five years and tweaking annually. Eventually, our fictional tale became reality. The doctor now has two homes. One is in San Francisco, where he has cut back on the hours he spends at his practice. He plans soon to retire to his vacation home in Monterey, where he will keep his hand in the field of medicine that he so enjoys by taking a part-time consulting and teaching post. Thirty years after the doctor first sat down to think about his goals, he reached his long-term target. But he did it one year at a time. So can you. This process is really part of your whole lifes financial planning that overarching bigger picture that includes everything from mundane bill paying to wills and estate planning. Because this book is about investment planning, we wont go into as much detail about every goals moving parts as a total plan would dictate. Whats important for our purposes is to establish goals that are challenging but achievable. I also strongly suggest that you write them down and keep them in a place where you can frequently revisit them. Why? The physical act of writing helps imprint goals on your brain. This is particularly important in this day and age, when we are constantly bombarded with information about stock market actionevery minute and every hour. If your own goals fade youll end up lost in a sea of data. If the stock market is down for the year and you break even, youll question whether you won. When its up 27 percent and you achieved only 15 percent returns, youll ponder whether you lost. Those are fine questions to ask to help keep things in perspective. But the really important question is, did you meet your own benchmarkyour own goals? Hayden Play: Be your own benchmark. Benchmarks like the S&P 500 may hold the public spotlight, but they must be secondary to your personal benchmark. Focus on what returns you reasonably need to meet your goals. Knowing your benchmark can enable you to avoid assuming more risk than necessary. Keep your eye on your game, not the one on the next field. Element Two: Return RatesHow Fast Can You Drive? After deciding on the time period you have to reach your goal, the next element of a goal to take into account is your return rate. This is essentially a reasonable assumed rate at which you expect your money to grow in your overall portfolio over an established period of time. Consider again that 1,000-mile road trip discussed back in Chapter 2. If you need to make that journey in no more than two days to attend your cousins wedding, youll have to log an average of 500 miles a day. The first morning youre golden. Fresh from a good nights sleep in your own bed, you hop in your car, pop in your favorite CD, and youre off on the dry, sunlit road. You drive straight through to noon with no rest stops and no traffic. But a steady downpour starts early in the afternoon. You drive barely 380 miles before collapsing in exhaustion at your hotel. You spend most of the next day speeding and watching your rearview mirror for flashing blue lights. Yes, you made it to the church on time. But you were so tired once you got there that you could barely keep your eyes open. You didnt have the fun you anticipated at all because you didnt consider just how difficult it might be to drive so far, so fast. You didnt account for the rain. The rate-of-return element of goal setting is a bit like planning the mileage piece of a road trip. If youre prudent, youll build in time to account for some bad weather or poor market years. At the same time, while the road or market conditions are right it would be foolish not to push yourself to go as far as you caneven beyond your estimated targetbut without doing any dangerous speeding. Over the years, some of my clients havent wanted to plan for the rain. Theyve come in enthused about the high return rates their friends are talking about and excited about conquering the market themselves. Who could blame them in boom years like 1999? More than 100 funds returned more than 100 percent (double your money in a year?!), and at least one was up more than 400 percent. But the bear market of 2000-2002 has brought home the fact that boom times dont last. Only those financial plans that plan for the rain do. I always try to do my darnedest to make the best out of whatever is happening in the market. But there is a difference between the targeted average return rates you can safely assume youll get over an extended number of years and what you manage to get in a given year. When establishing goals five years out or more, four basic ranges can be assumed. A conservative return-rate range is 5 to 6 percent. Moderate would be 7 to 8 percent. Aggressive, in my book, would be any assumed rate of 9 to 10 percentor more. Of course, to some degree these ranges shift up or down according to the particular cycle of the market were in. In fact, during real bear markets like the kind in 2000-2002, I ratchet my return rate goals down to what I call a bunker level of 3 to 6 percent. In times like these, youre basically aiming to protect your principal. What doesnt change are the labels like conservative, moderate, or aggressive. I want to stress that these are just examples of rates of return youll hope to get. There are times when being aggressive gives you a higher rate of return, but there are times when being aggressive gives you disastrous consequences. A higher rate of return usually means you are taking more risk, and higher risk doesnt always mean a higher rate of return. It could turn out just the opposite. The only reason to be aggressive is so you can hold out the hope of higher upside than youll get with conservative investing. So, how do you decide what rate to use when determining your return rate goal? As discussed in Chapter 2, part of the equation depends on your psychological risk tolerance. You can get a rough idea of which range to plug yourself into by seeing how you fare on the Risk Quiz. If youre risk averse, youll shoot for the conservative range, while the risk steady will go the moderate route and the risk seekers might brave 10 percent or above. The other factors are more quantitative. Traditionally, most people are counseled to take time and their ages into consideration. The important consideration to focus on here is really not age but rather the length of time you have before reaching your goal. The closer you are to needing the money from your investments, the less advisable it would be for you to assume higher risk. Thats because the probability of your achieving those higher returns is less likely than your achieving the lower but safer returns. The shorter the time frame, the less predictable the returns are, and the less time you have to make up for any missteps. Another element that comes into play is income. An engineer earning a $60,000 income simply has less money to invest than a corporate executive who makes $500,000. Because that engineer has less to invest, he also cant afford to take the greater risk that would be necessary to grab that brass ring by putting together an aggressive portfolio with a 10 percent return rate. Its an unfortunate reality of investing: The less money you have, the less you can afford to make a big mistake. I generally try to steer people to more conservative territory. I havent always had a lot of company in my camp. The majority of people in the financial industry tend to use 10 percent, a number I consider to be in the aggressive range. But in the throes of the bear market that raged through the years 2000 to 2002, more investors heeded the siren call of prudence. Respected financial thinkers like Warren Buffett are projecting return rates as low as 7 percent over the coming years.1 Still, the bottom line on return rates is that nobody can accurately predict them. No matter how hard you work on establishing a realistic goal, you probably wont get the return rate youve picked. I cant emphasize this enough even though I know its frustrating to hear. After all the work youve put in, how could that be? Because the markets are highly unpredictable. And even the financial industrys best high-tech wizardry has a significant flaw: It is all based on the past. |
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