Friday, September 18, 2015

Back to Basics: “Invest” Means Something Different to Everyone

One day last week, I had two interactions that reminded me that there is no common definition for the word “invest.”

First, I was completing an interview with Matt Gephardt from KUTV news. During the discussion, Matt asked if it was a good time to invest. Immediately, I assumed he was referring to the volatility that the stock market has recently experienced and I provided my opinion that volatility was ultimately a good thing because it penalized short-term speculators and provided profitable opportunities for long-term investors. As I spend a lot of energy encouraging clients to focus on achieving their long-term financial goals and paying minimal attention to short-term market movements, I said I wouldn’t hesitate to invest given the current market environment.

Further, as Matt is a young individual with several decades before retirement, investing early and utilizing as much time as possible to allow his portfolio to compound would clearly be beneficial. Investors with such an extended investment time horizon will certainly experience their share of market pullbacks, corrections, and even crashes. Yet, history strongly suggests that the simplest way for young investors to achieve wealth is to get invested dollars working for them as early as possible.

It wasn’t until later that I realized Matt very well could have been asking if it would be wise to invest money now after a market pullback and hope to quickly profit from a bounce or a quick recovery. This would have certainly been a fair question as such action would clearly fall within the definition of investing. However, if I had interpreted the question in this matter, my answer would have been completely different. I would have responded that I have no idea what the market will do over the next week, month, or even year, so if you are looking to make money over the short-term I can’t say that investing now is an action that I would recommend.

The second interaction involved an email exchange with a new client who is about to transition into retirement. This individual has historically been an extremely conservative investor, having his entire nest egg invested in cash equivalents (CDs, money markets, and savings accounts) for the last several years. However, he has recently recognized that such investments won’t provide the income that he desires throughout his retirement.

I’ve worked with this individual to produce a financial plan and investment strategy that we are both comfortable with, so the next step is to put the plan into action. However, the client expressed concern about investing amid the recent volatility. While this is certainly a valid concern, it made me realize that the client and I were using the term “invest” to mean different things.

I believe when the word “invest” was used, the client logically concluded that the entire cash balance would be invested in the market immediately. This would be a huge transition and could certainly be scary.  By comparison, to me “invest” meant starting the process of slowly moving money out of his cash balance and putting it to use in more assertive assets by dollar-cost-averaging over time. This could take 12-24 months, dramatically reducing the client’s exposure to short-term market movements.

Further, it became increasingly clear that although the client and I had discussed and agreed upon an asset allocation that may consist of only 30% stocks, the client hadn’t yet incorporated the mindset that only 30% of his portfolio would be subject to the volatility of the stock market. Admittedly, if the market were to drop 10% immediately after investing your life savings, that would be a frightening experience. However, if only 30% of the portfolio was invested in stocks when the market declined by 10%, the investor’s loss would have likely been only approximately 3%. While enduring a loss is never pleasant, an immediately loss of 3% would be a lot more manageable than a 10% portfolio reduction.

With Matt, he and I may have interpreted “invest” as a way to obtain completely different goals – profiting from the current market environment vs. obtaining long-term financial goals. In my interaction with the new client, our slightly different interpretation of the word “invest” was leading us to envision scenarios with drastically different risk implications.

Of course, it is possible that both Matt and the client could have meant various other things while discussing investing in today’s market. The point is that the term “investing” is frequently not sufficient when communicating with others. What are the goals you hope to achieve with the investment? How long do you intend to hold the investment? What assets will you actually be investing in?

While these may seem like basic principles, it is possible that a commonly understood definition of the word “invest” may be lacking during some communications, whether those discussions are taking place between spouses, financial advisors and their clients, or between families and their accountants and attorneys. Every once in a while, it is probably worth ensuring that the people you work with possess an understanding of what the word “invest” means to you.

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