No free lunch when it comes to investments

When I listen to financial radio ads or shows, I am always amused how they present a scenario which is incomplete, incorrect, skewed or just completely wrong.

The scenario always leads back to a product the commentator wants to sell. Thus, the real motivation is selling a product for the financial benefit of the commentator rather than helping clients make sound decisions.

One example which I find annoying is the pitch starting with some phrase like how to avoid losing money as you did in 2008. Let us dissect this comment a bit.

The phrase about losing money is misleading. Investors did not misplace the money. The value changed. Note that for any investment, like a mutual fund, the value is the product of the shares owned times the value per share on that day. If the price per share declines, the value declines but the number of shares does not unless the investor sells the shares.

For both tax and investment purposes, selling the shares creates a “realized” transaction. If you do not sell but retain the shares, then you retain the tool to benefit when the price rises again. Selling completes the matter and then you have indeed suffered the loss in value. You cannot recover the value without the shares.

Holding the shares in turbulent times may be uncomfortable but it does provide the method to benefit when prices rebound. Selling the shares means you have lost the opportunity to benefit from the future price increases.

When you invest in the capital markets, you must accept that they are turbulent and subject to downturns. Too often people take a short-term view and expect more stability than is normal behavior for capital markets. Investors with short-term plans for the money should keep the money in a different type of financial tool that matches their needs. The stock markets have normal behaviors which are compatible with long-term investing but certainly not with plans to use the money soon.

If you examine the history of the entire U.S. stock market since the Great Depression in the 1930s, (a period of 83 years) you will find only three times that you would not have a positive return if you had held your investments longer than five years, and none if you look at a 10-year holding period.

The pattern is clear. Match your investment strategy to your spending plans. Then let it work for you. Control the financial risks using well-established and evidence-based tools. You will receive a rate or return for taking such risks. Let the global financial markets work to your benefit. Do not expect them to behave differently just because you put in some money.

Most of the fancy products offered for sale state that you only get positive results and never suffer negative results. But someone must bear that risk. In fact, the product company takes the risks, receives the full rate of return and doles out just enough to those who buy the product to make them feel satisfied.

There is no free lunch. The real question is how to manage the financial risks in a way that is compatible with your needs and your psychology.

Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from the University of California, Berkeley. Contact him by email at [email protected].

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