If You’re Going to Invest in the Stock Market… (Diversification Strategies)

“One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute.”
– William Feather

The stock market has been feeling VERY bullish lately, hitting 10 new highs in the last 10 days before a lull today. The bulls love Trump’s promises of decreased regulations and “big league” tax breaks for business.

We’re happy for all whose portfolio ticked up this month, and as the market breaks old records, it’s an excellent time to look at the big picture of your finances and consider some changes, especially if you’ve got money in the stock market.

A Different Financial Philosophy

First, let us admit that we’re a little biased. Partners for Prosperity advocates Prosperity Economics. It’s an alternative to financial planning that, unlike typical financial advice, doesn’t rely on stock market speculation to build wealth.

Prosperity Economics advocates that investors maintain a level of control over their finances, instead of delegating financial results to the markets, the government, or an employer who can legally move dollars from your paycheck and put them into mutual funds without so much as your signature.

(You know how some companies will send you junk mail unless you take the trouble to opt out in writing? Automatic enrollment for 401(k) plans works like that, thanks to some very effective lobbying of Congress by large financial corporations.)

It’s not that investing in the stock market will necessarily lead to a disaster. It could be very profitable! The point is, whether it climbs or falls, it’s out of your control. And since you can’t control the stock market, the more money you have in the market, the less control you have. Many are willing to give up some control for higher returns, but risk does not necessarily lead to better results, especially when a 50% loss must be followed by a 100% gain to recover the loss!

(Control is one of our 7 Principles of Prosperity™ and you can find out about all seven here.)

So… you’re in the stock market.

In spite of the potential downside, the vast majority of investors have money in the stock market, so much so that the word “investment” is almost equated with owning stocks or mutual funds.

Most people are advised that putting money in the stock market is the best long-term investment.

Others were automatically enrolled by their employer into a mutual-fund based qualified retirement plan such as a 401(k).

Some people are chasing the 12% returns that Dave Ramsey promised them, even though the market might be more likely to deliver 4-7% possibly even less, as we explored in last week’s post, “The Ups and Downs of the Dow Jones (and Why We’re Not Impressed).”

Many people would love another option, but don’t know where else to put their dollars.

Regardless of how you got into the market, here are some strategies to limit your downside, increase stability, and do it wisely rather than foolishly:

1. Save First.

Many people start investing before they save, and that’s backwards. (If you’re not sure of the difference, see this video in which I explain that saving and investing are NOT the same thing!)

You should always have liquid savings that allows you to handle emergencies or take advantage of a rare opportunity without disrupting your investments.

2. Expect Volatility.

There is truth to the statement, “Never invest more than you are willing to lose.” The stock market is a roller coaster ride and if the thought of losing your money makes you queasy, you’re best to avoid it.

Yes, the stock market has always gone up “over time,” but that doesn’t guarantee you’ll make a profit in any particular 5 or even 10-year period. And what is the emotional cost of extreme volatility we’ve seen over the last few decades? Your investments shouldn’t keep you up at night.

We’re programmed by typical financial education and advice to accept that volatility and risk are normal and unavoidable when it comes to investing, but that’s simply a myth perpetuated by the high priced advertising from big brokerages that infiltrates our media.

3. Limit Your Exposure.

It’s said, “Never invest more than you are willing to lose.” The more money you have in the market, the more risk you are taking on and the more money you could lose in a downturn. We recommend limiting your market exposure to no more than 20-25%.

If all of your investment dollars are in the market, that means you’ve got some diversifying to do. We’d recommend reinvesting some of those dollars in different asset classes, although if your dollars are trapped in mutual funds in a retirement account with limited options and/or penalties to remove, you could also simply invest new dollars elsewhere.

4. Diversify

Note: “Diversification” is not buying 10 kinds of mutual funds (small cap stocks, large cap stocks, value stocks, an ETF that tracks the S&P 500 and funds that represent various sectors of the economy such as healthcare, tech, energy, etc.) — although we would recommend broader market holdings as opposed to narrow holdings for those in the stock market.

True diversification means investing in different asset classes. To balance out your stock market holdings, consider saving and investing more money in assets such as:

Real Estate:

  • Purchase rental real estate such as residential homes or a commercial office space.
  • Be a private lender for bridge loans or bridge loan funds that lend money to developers for the purpose of improving or rehabbing a commercial property.
  • Own your own home. If you are just starting out saving and investing, you may still be renting. Don’t forget that it’s extremely difficult to build wealth while spending many hundreds of dollars each month on rent, while building zero equity. See our “Savvy Home Buyer’s Guide” excerpt from Busting the Interest Rate Lies for a shocking rent vs. own comparison.

Life Insurance:

  • Whole life insurance purchased from dividend-paying mutual companies (owned by policy owners) set up with a special rider to increase your cash value is a much better long-term savings vehicle than a bank account. Typical gains are 2-3% higher than savings accounts, plus you secure a death benefit that can provide a legacy and help you reduce taxes and spend down other assets while living. (Download “Permission to Spend,” a 16-page special report, to find out more.)
  • Life Settlements provide investors with healthy, stable returns (no roller coaster rides) by allowing them to invest in the secondary market for life insurance policies.

Business and Personal Lending:

  • Having your own business is a fantastic way to invest in yourself, perhaps turning a passion or hobby into profits.
  • If you want to invest in someone else’s business, consider only lending to profitable businesses for specified returns such as an agreed-upon interest rate, rather than simply speculating.
  • Websites like Prosper.com and Lending Club remove banks from playing the middleman, matchmaking borrowers and lenders and allowing lenders to earn interest paid by borrowers.

(If you’d like our help with a stock market diversification strategy, reach out to us. We have some excellent options for both accredited and non-accredited investors.)

5. Rothify

If you have money in a traditional 401(k) or IRA and you have the ability to move it into a Roth or a Roth IRA, look to see if it might make sense for you to do so. You’ll take a tax hit now, but then your future growth will be “yours” to keep without worries of what the tax rates will do next.

There is also an option to potentially SAVE on some of those taxes now by setting up a self-directed IRA and doing an innovative Roth conversion using life settlements.

6. Watch Those Fees!

Comedian John Oliver and Vanguard founder John Bogle agree on one thing: “Keep your fees low, under 1%.” This is VERY difficult to do in a 401(k) or other employer-sponsored plan because employees (especially with smaller companies) will typically find themselves paying 3% or more when you add up the various fund fees, plan fees, brokerage fees and administration fees.

And 3% in fees doesn’t just lower your results by 3%… just like interest has a compounding effect over time, so do fees. Studies such as The Retirement Savings Drain demonstrate how those “little fees” can eat up nearly ONE THIRD of the money that should have been yours, costing a median-income two-earner family nearly $155,000! For that reason and more, we recommend…

7. Build Assets Outside of Retirement Plans

As Garret Gunderson argues in Killing Sacred Cows, 401(k)s and other government-sanctioned retirement plans trap your money and limit your options in ways that can actually compromise your prosperity by limiting what you can do with your money.

Want to build equity in a second home you can use for vacations and rent out at other times? You can’t own that type of property in a self-directed IRA, there are strict rules against using funds to purchase a property you can use yourself.

Want to start a business on the side before you’re 59-1/2? You’ll have to pay through the nose in taxes and fees to free your own retirement funds for that use.

It can make sense to take advantage of an employer “match,” but we never recommend funding qualified plans to the “max.” You’ll have much greater freedom with your own money by building the majority of your assets outside of retirement plans where you have much greater flexibility and control.

There IS Another Way!

As mentioned above, it’s called Prosperity Economics. It’s the financial philosophy that many wealthy people use to create wealth outside of the stock market, with greater security and less risk. Find out more here by getting Kim’s recent ebook, Financial Planning Has Failed.

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