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Playing Favorites

Playing Favorites

| October 17, 2017

We all have favorites. There’s a familiarity and dependability when you order your favorite food at your favorite restaurant while sitting at your favorite restaurant. In fact, now that I have a three-year-old, we rarely venture past three different restaurants that are her favorite. It’s just not worth the risk that we won’t find exactly what she wants and then we’ll deal with the terrible threes.

The problem with favorites comes when you are no longer three years old and you need to plan for retirement. Having a favorite investment or investment strategy can cost you. Let me share some examples:

Buy and Hope

When a prospective client schedules an appointment, part of the process is reviewing their existing retirement plan. On several occasions, I’ve come across “conservative” investors with an all stock portfolio. The concern here is that stocks provide long term growth, but along the way can experience more volatility than an otherwise diversified portfolio.

When I mention this issue, the reply is something to the effect, “Well my granddaddy used to say, just buy blue chip stocks and hold them forever.” I have to bite my tongue while simultaneously explaining the difficulty of this type of strategy. For every McDonald’s or IBM, there are K-marts and Polaroids. Just look at the story of the Nifty Fifty.

Frying Pan to the Fire

The other extreme I come across is when a person has been burned by market volatility and vowed to never see a market loss again. Their portfolios are heavily weighted towards cash and bonds. They’ve sworn off the frying pan of volatility and landed squarely into the fire of inflation.

Actually, inflation isn’t analogous to a fire. It’s more like a pot of water that is very slowly being brought to a boil. At 3% annual inflation, your cost of living will double in approximately 20 years. That means your $100 of income will buy $50 worth of goods. That type of inflation is almost imperceptible in real time, but disastrous when you start taking withdrawals from your investments to live on.

Also, for the last twenty years our average annual inflation has been about 2.15% (1996 to 2016). That may feel pretty comfortable and create a subconscious bias towards projecting low inflation going forward. But keep in mind from 1970 to 1990 the average annual inflation was 6.3%. To put that in perspective, $337 would be needed to buy $100 worth of goods. At either extreme, cash loses buying power in your portfolio.

You are Not a Three Year Old

While we would love to dine on mac and cheese for breakfast, lunch and dinner, we don’t. Why? Because we are not three years old anymore. As adults, we learn that proper nutrition means variety and portion control. It’s perfectly fine to have that slice of pizza, but let’s make sure that we are also learning to appreciate brussel sprouts. We do this by educating ourselves on the good and bad attributes of all the food we eat.

Likewise, your retirement planning allocations should look like a well-balanced meal of things you “like” and things you are “learning to like.” Understanding the purpose that an asset has in your portfolio can help you learn to like it. But more importantly it will provide you with a sound retirement plan that can afford all the mac and cheese your heart desires.

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