Of all the investment advice I’ve ever heard, the economist Gene Fama, Jr.’s is my favorite: “Your money is like soap. The more you handle it, the less you will have.”
For me, that conjures up an image of working up a big lather in the shower. Although it may appear as if your scrubbing creates something solid, the rich lather quickly washes away. What’s more, your efforts leave the bar of soap diminished. Similarly, most of the time when you give your portfolio a good scrub, at best you create temporary gains (lather) that will be washed away by the stream of water (efficient markets.) What’s more, trading costs eat into your nest egg, leaving it like a shrunken bar of soap.
Indulge me while I push the metaphor a little further. When you hold soap in your hands, it becomes slippery as the water pelts down. Turn the bar around to lather up and there’s a chance it will slip from your hands. In fact, the bigger the bar (or the higher your net worth), the more difficult it can be to hang onto. Here, I equate the unrelenting water pelting from the showerhead as the bombardment of “can’t miss” investment ideas presented by your friends and colleagues that can damage your portfolio.
Am I telling you to leave the soap on the shower shelf, to ignore your portfolio? Certainly not. However, it’s important to realize that our emotions — most often fear or greed — spark illogical, unnecessary, and even destructive investment moves. Although research continues to prove it’s impossible to time the market, investors persist in believing they can do just that. Pouring money into equities when the market is up and selling when it goes down, investors trap themselves in a vicious cycle of buying high and selling low — and earn substantially less than index returns.
So, what should you do? Because the markets move up and down beyond your control, work with a trusted financial advisor to construct a diversified, risk-appropriate portfolio you can live with in all markets. Diversification among dissimilar asset classes is the only academically-proven risk control measure that delivers consistent, and potentially enhanced, returns. Also, the next time you get the hankering to scrub, remember that a conscious decision to remain invested in your diversified portfolio is, in fact, a form of action. If you really must do something, we’ll take a look to see if you need to rebalance to maintain your ideal asset allocation. Remember, your bar of soap has got to last you for decades.