Financial planning is more complicated than it seems. Marc Lowlicht of Further Lane Asset Management handles the affairs of high net worth clients and spends a lot more time handling tax, estate and probate issues than he does choosing investment managers. The portfolio, he reminds us, is just one part of the picture.
So how complicated does the portfolio need to be? One consequence of the recent democratization of the markets is that virtually all investments are open to all people. Mutual funds and exchange-traded funds now mimic returns from private equity and hedge fund partnerships that are forbidden to retail investors. Stock options are now available through retail brokerages like TD Ameritrade (nasdaq: AMTD) and Charles Schwab (nasdaq: SCHW). Foreign exchange markets are available through retail Internet platforms and through ETFs. Same with commodities futures.
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The idea here isn't to say that you should never do these things. It's just that for most people a core portfolio of stocks, bonds and cash will suffice to generate good returns for retirement, college planning or to build an estate. The fancy stuff can work; it's just not required.
Nobody can master everything and, on Wall Street, few even try. Sure there are go-anywhere savants like Robert Bruce of the Bruce Fund (BRUFX) who seem as comfortable in currencies and debt instruments as they are stocks, but most people on Wall Street tend to specialize in one asset class—the currency analyst, macro-economist and stock analyst might share interests, but they don't usually share jobs. There are myriad skills to master in any one asset class.
The good news is that the typical investor really doesn't need to master them all. There's nothing wrong with adding options, commodities or a private equity ETF to your portfolio; it's just that you really don't need to. A diversified portfolio of stocks and bonds will probably do just fine.
The evolution of financial products has been the story of plenty. In the 1970s, when retail investors first started to purchase mutual funds en masse, Forbes magazine used to be able to print the returns and expense data of every fund available to an American investor in its annual mutual fund survey. Now there are more than 9,000 mutual funds on the market with more than US$12 trillion in assets, according to the Investment Company Institute. ETFs were first launched in the 1990s, and there are now more than 700 of them, according to ICI, with more than US$600 billion in assets. The explosion of new funds, especially ETFs in the last decade, has given people access to asset classes that used to only be available to professional fund managers or traders.
The Internet has also made investment techniques more available, especially when it comes to shorting stocks, investing in options, buying or selling currencies, or obtaining a margin account. All are valid ways to invest. But most people will never need to borrow money in order to invest. The problem with borrowing money is that it means the investment return has to beat the cost of the borrowed money or else the investor risks losing more money than they put in. Margin can amplify returns, but it can also amplify losses. It's best avoided by individuals, because the only sure winner in a margin relationship is the bank that's lending the money.
Shorting stock is another valid but unnecessary tactic. It can lead to larger losses than the amount invested, and it can put a small investor at odds with company management. The small short can sometimes get steamrolled by well-positioned people who are shooting for big bonuses. This isn't to say that shorting can't be done well (or that it isn't a public service, because, frankly, shorts are often the market's gutsiest truth tellers). But it's not for the casual investor, and sometimes discretion is the better part of valor—see a dog of stock? Avoid it. The good news is that some well capitalized funds like the Prudent Bear can give you a better and safer shot at this.
Same with options. Institutions use options, a contract that gives the owner the right (but not the obligation) to buy (call) or sell (put) a security at a certain price, as a way of mitigating losses in a portfolio or to lock in gains. Over the last decade, options trading has become cheaper and available to the masses. To say that only sophisticated investors should ever dabble here probably overstates the complexity of the asset class. They're just not usually necessary. The option to buy or sell a stock is nice to have, but it isn't free and stocks are liquid enough that for most investors being able to execute small trades at desired prices isn't a major issue.
Foreign currency, through either ETFs or a foreign exchange account, might seem tempting, especially with the dollar under pressure. But remember, according to a
Bank of America (nyse:
BAC) strategist, even the S&P 500 gets at least 15% of its earnings from overseas—investing in big global companies can provide some implicit currency protection. Buying cheaper, liquid foreign stock funds can add to that hedge.
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In Pictures: Investments You Don't Need
