Searching for the Perfect Investment - Part 2

Searching for the Perfect Investment - Part 2

[caption id="attachment_437" align="alignleft" width="150"]John G. Finley, CFA John G. Finley, CFA[/caption]

In Part 1, we looked at some of the difficulties in managing your portfolio. Here, we will look at why the perfect investment does not exist.

Questions About Investment Strategies? —You Bet

Next, we must decide the best way to implement our investment choices: separately managed accounts; open-end mutual funds; closed-end funds; exchange-traded funds? What works best for you? Should we consider a passive, low-cost index fund approach or find managers who can beat the market indexes through active management?

The question of approach is also important. Should we use a technical approach, such as trend following, or a fundamental approach such as value investing? Should we try to time the markets? How hard can it be to sell all your stocks just before the next big market downturn, then buy them all back just before the next market upswing? Maybe we should buy-and-hold? What about day trading?

No Such Thing As Simple Answers

Take a deep breath…Help is available. For the do-it-yourselfer, Amazon.com presents fertile ground to help us out here, as well. The website offers 26,000 book titles related to investing. For those who prefer to outsource their investing decisions, there is no shortage of financial advisors and investment firms, large or small, available to assist you.

“The simple believe everything, but the prudent gives thought to his steps" – Proverbs 14:15

By this point, it’s probably obvious that simple answers to complex problems—in our families or in investing—are few and far between. Why does it all have to be so complicated? Gallup polls consistently show that Americans rank gold as the best long-term investment1. Every day we see commercials or print ads touting the security of gold. So, why not just buy gold and forget about it?

Or “Sell in May and Go Away”?

The Mythical Perfect Investment

Admit it. At one time or another, we have all experienced an insatiable yearning for the “Perfect Solution” to many of our complex problems, from parenting to investing, and everything in between. For the past several years, I have had the privilege of being an adjunct finance professor, teaching primarily the fundamentals of investing. To introduce the topic to my students, I often ask them to describe what they would consider to be the characteristics of the “Perfect Investment”. We usually end up (with a little prompting from me) with a list similar to the following:

  1. It always goes up in value
  2. It never goes down in value
  3. It pays out an ever-increasing stream of income (in excess of the cost of living)
  4. There are no risks to owning it (losses, inflation, credit, currency, interest rate, etc.)
  5. You can sell it whenever you want to at its current value (very liquid)
  6. You pay no taxes on the income or capital gains
  7. There are no fees associated with owning it or trading it

Of course, such an investment does not exist. In the real world, you don’t get something for nothing. We just know in our bones that you can’t get a decent return without having to assume some kind of risk.

But would a nearly risk-free investment get us close to the mythical “Perfect Investment”? Take the short-term debt obligations of the U.S. Government, called Treasury Bills, which are extremely liquid (#5). The current one-month T-Bill guarantees return of your principal (backed by the taxing power and/or currency printing presses of the U.S. of A.). After a year of rolling over your investment twelve times, you will receive a whopping 0.03% for your efforts (assuming current pricing). Since there is very little volatility in the price, it will never go down in price very much (#2), but it will also never go up very much either (#1). But owning it can eliminate several of the risks listed in #4 (loss, credit, currency and interest rates), but not the risk of loss of purchasing power (inflation). And, as long as the Fed has an accommodative Monetary Policy in place, you can forget about #3. Oh, and before I forget, it’s really hard to avoid paying taxes and fees, #6 and 7!

Okay, so let’s get real now. In Part 3, we will get the practical details on a fantastic investment.

In Part 3, we will discuss the best strategies for making the best investments.

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