Picking Investments
Tires Can Teach Us About Picking Investments
I bought new tires a few weeks ago in anticipation of my annual state inspection. I was killing time in the waiting room at the shop and I started to think about financial planning analogies. How could new tires possibly have anything to do with picking investments? Buckle up (car pun ftw)!
Risky Business
A good fee-only financial planner (like me) will help you take a comprehensive look at your entire financial picture. Picking investments is only part of the service I provide. I carefully review my clients’ goals, cash flow, taxes, savings, insurance, employee benefits, and a lot of other information before we start picking investments. I make investment recommendations based on a client’s risk tolerance. Risk tolerance can be thought of as your investment personality. Do you have the means and emotional ability to take on certain thresholds of risk in pursuit of various levels of return? Basically, if the more risk you take tends to yield more reward, how much pain can you take when markets don’t cooperate?
Risk tolerance can be assessed in a variety of ways. The important thing to remember is that everyone has a different risk tolerance, and their investments need to respect and reflect that. It’s kind of like picking tires for your car.
Built For Speed
Have you ever ridden in a sports car? The tires on a sports car (modern ones anyway) are complements to the performance of the engine, transmission, and suspension. They help the car grip the road more than regular tires, and they’re meant to go fast and be driven more aggressively than a daily commuter. I have an uncle that has enjoyed various Porsche 911’s over the years, and he was foolish enough to let me drive it for a few brief terrifying/exhilarating minutes during my high school graduation party. I will never forget the sensation that the car felt like it was on rails, and no matter how much I tried to goose it around a corner, it just would not let go of the road. Low-profile or performance tires are often very thin and don’t exactly offer much in the way of dampening bumps in the road. For those of you that have ridden in a sports car, you might remember the ride being rough, or downright abusive if you hit any kind of bumps or potholes. The car’s suspension and tires are meant for going fast and holding onto the road at higher speeds. They are not necessarily built for comfort.
This is akin to the way we build investment portfolios. Performance tires are like an investment portfolio that is mostly or completely comprised of exposure to stocks. Stocks, as an investment, are selected for their growth potential. They usually go up, but go down too. When they go down, it hurts because it is usually a quick, violent descent, taking your 401(k), IRA, investment account, etc. with it (temporarily!). Market declines with a portfolio mainly comprised of stocks can be thought of a sports car with performance tires going over a rough patch in the road. The experience will be markedly different than a car with different tires.
Built For Comfort
I come from a Ford family. My parents drove Fords. My grandparents drove Lincoln (a Ford company) Towncars. Lincolns, in particular, are built for a smooth, comfortable ride. The tires on those cars are basically marshmallows, meant to gobble up potholes and imperfections in the road. They are not meant for any kind of performance handling. Unlike the performance tires of a Porsche, the big “squishy” tires on a Lincoln are like an investment portfolio with more bonds in the mix. The additional rubber and air are meant to smooth out the ride, the way bonds are meant to diversify risk and counteract volatility and market declines in an investment portfolio.
There Are All Kinds Of Tires
There is a lot that goes into selecting the right kind of tires. For instance, tires are sold by type, width, aspect, dimension, load, speed, traction, etc. There are a LOT of factors. Each car calls for a different kind of tire, and that’s no different than investors with different risk tolerances and goals. Their tires, or portfolio, will look different than the car (portfolio) next door. For example, a Porsche isn’t going to have the same tires as Pop-Pop’s Cadillac, and a younger client probably won’t have the same portfolio as someone that’s on the doorstep of retirement. As of 2018, Forbes estimated there were more than 10,000 mutual funds and Exchange Traded Funds (ETF’s) in the United States. Considering investors don’t pick just one, that’s a lot of different ways to build a portfolio. That doesn’t even count individual stocks and bonds. Remember permutations from high school? A mutual fund portfolio with 10 funds in it (of the 10,000 available) can be assembled 2,743,355,077,591,280,000,000,000,000,000,000 different ways. I know what you’re thinking. Of course I did that in my head! But seriously, I dare you to try to say that number out loud. Consider the fact that the permutation assumes an equally-weighted portfolio, which is probably unrealistic too. Point being, there’s a lot to pick from, and just like a mechanic will usually tell you what kind of tires you need, I can offer guidance when picking investments that are a good fit for you and your goals.
You Need To Change Your Tires
You will probably have different cars that require different tires over the course of your life. Furthermore, your investments and risk tolerance will probably change over time too. Tires, like investments, need to be changed from time to time, even if you don’t have a new car. Tires wear down. Go flat. Pick up a nail once in a while. They literally have to pass an inspection on an annual basis. The same holds true for your investments. A fee-only financial planner (like me) can help you monitor your “tires,” and make sure you pick the right ones for your particular vehicle. The reality is that if you buy tires that aren’t great, a couple of hundred bucks will set you up with some new ones. The same can’t be said for picking investments. Time is your best friend as an investor, but it can also be your biggest enemy. There are very real opportunity costs to portfolio management and mismanagement. Feel free to shoot me an e-mail to get started at brendan@meaningfulwealthmanagement.com.