True or false: Investing in the stock market is riskier than heading to the bank and purchasing a CD?

Actually, this is a trick question because the answer is: It depends! It depends on what you mean by “risk.” When investing over the long haul, there are two types of risk to consider.

Investment Risk

When you invest in the stock market, your holdings might go up (reward) or they might go down (risk). These gains or losses show up as real dollars that you can see in your monthly account statements, and they can be exciting or scary to watch, depending on which way they’re headed. That’s investment risk.

Hands down, it is absolutely true that you face a lot more of this type of investment risk by participating in the stock market than by purchasing CDs or similar kinds of “fixed income,” where a penny saved is highly likely to be a penny earned. For better or worse, your CD’s monthly statement will pretty much look the same every month.

On the other hand, by investing in the stock market, you are expected (although not guaranteed) to earn more real return than from purchasing fixed income such as CDs — if you stay the course and stoically accept the required investment risk. Historically, that equity risk premium has been around 5 percent per year.

Compare this to inflation, which has been around 3 percent per year … and which brings me to my next point.

Inflation Risk

While stocks are more vulnerable to investment risk, fixed income is far more vulnerable to inflation risk, or the risk that the purchasing power of your money will decrease over time in the face of inflation.

Think of it like a leaky bucket, in which the drops of water being added (such as CD interest) aren’t enough to compensate for the hole in the bottom (inflation). Or, for a real example of how inflation impacts your spending power, consider the price of postage. It cost you $0.06 in 1970 versus today’s $0.44 to deliver the same letter.

Inflation risk can wreak havoc on your wealth. There are periods, sometimes lengthy and severe, during which purchasing power is so diminished by inflation that “safe” investments actually yield significant negative real returns when measured with their ability to keep pace with inflation. In addition, inflation risk is insidious, because the damage doesn’t show up us obviously negative numbers in your monthly returns statements. Dimensional Fund Advisors’ CEO David Booth provides a fascinating presentation on the subject, which I recommend you view for more details and specific data-driven illustrations on the subject.

Let’s return to our true/false question: Are stocks “riskier” than CDs? As is so often the case, the truth seems to lie between the two extremes. The best way to manage risk is by building a well-diversified portfolio that controls for inflation risk with equities and dampens investment risk with fixed income.

When you reflect on your life to date, what distinct experiences leap to mind as the most inspiring? Was there a spectacular event that left you aglow to this day? Maybe an encounter with someone who made an enormous difference to you or your family. Or perhaps it was simply a quiet moment of insight generated by an extraordinary idea.

I recently experienced an occasion that represented all of the above and more for me. Before you worry that I’m being overly sentimental let me assure you, my epiphany involved jet engines so loud they literally rattled my bones. I’m referring to my recent participation in the Navy’s “Leaders to Sea” program (that’s a group shot of us at lower right). During my 24+ hours aboard the aircraft carrier USS Harry S. Truman, I was privileged to witness operations as the ship and crew performed requalification exercises off the coast of Norfolk, Virginia.

Too often in life, we are inspired to action, only to let the moment pass. This time, I didn’t want that to happen. Instead, I am thrilled to announce my personal Web site recently launched – http://gonavy.poseycapital.com -- dedicated to sharing my onboard experience. I hope you’ll take a moment to tour my new site. (My personal favorite page is the Flight Deck Tour, so if you only have time for a brief visit, feel free to begin there.)

During the coming months, I want to network with people who are interested in learning more about the Navy. It’s one way I hope to pay back the Navy for the amazing experience they shared with me. Please help me spread the word by sharing this site with others. Feel free to:

• Link to this site from your own site(s)
• Tweet about it
• Add it to your Facebook resources
• E-mail the link to those who would find it of interest

Or contact me if you or your group would be interested in learning more.

If you were strolling through the park and a clown wearing purple and yellow polka-dots wheeled past you on his unicycle, you’d probably notice him, right? If you were on a cell phone at the time, think again.

A study published in a recent issue of Applied Cognitive Psychology discovered that 75 percent of the cell phone users in the study suffered from “inattentional blindness.”(1) In other words, three quarters of them did not report seeing the clown.  Now, imagine if you put these same people behind the wheel of an SUV.

Regardless what you think about cell phone use, the study also illustrates how hard it is to keep track of everything at once. Juggling your child’s band practice with picking up cold medicine for your ailing spouse, working over the lunch hour on that critical paperwork, meeting the cable repair company “sometime between 1 pm and 3 pm,” and … Well, you get the idea.

How much time and energy do you have left for thoughtful reflection about your investments?  If you’re like most people, you end up having to make important long-term decisions about your money while surrounded by short-term distractions. To make matters worse, financial news often leaves people feeling as if they must react whenever something particularly good or bad happens in the markets.

Sure, I have my own life’s distractions just as anyone else does, and I enjoy spending time with my wife and our young son every chance I get. But as an independent investment advisor, I am able to devote my entire professional career to keeping clients’ best financial interests at heart, even when they may be incredibly busy with truly important things in their lives, such as taking care of their family or pursuing their personal and professional interests. For example, I can take the time that my clients cannot always find, to carefully consider their investing in a larger context. Wealth management is about more than simply creating piles of money. It also should include planning to spend that money before and during retirement; mitigating unforeseen risks through appropriate insurance coverage; considering the family or philanthropic legacy you hope to build; and more. It’s a career that I love, and I wouldn’t trade it in for the world.

While we’re on the subject of cars, I’d also like to follow up on a blog I posted in late September, in which we offered tips on purchasing cars with minimum hassle. One of our tactics was to distribute a “request for proposal” or “bid” to a variety of dealers in the region before spending our time meeting with them personally. This helped us compare and contrast dealers in an apples-to-apples way, without having to drive all over town. Here’s a fax/e-mail template you can use for this purpose.

I wish you a safe, distraction-free driving experience, for both your car and your wealth!

What do you think about government intervention: in our health care system, in the auto industry, in our economy in general? Whether you feel good, bad or indifferent about it, many clients (and I) have been concerned about the impact it might have on the stock market. Is more government bad for investors?  

Before you decide, I encourage you to invest five minutes to enjoy a fascinating presentation by Dimensional Fund Advisors Vice President Weston Wellington, “Government Intervention and Stock Returns.”

Weston analyzes past returns and data from other countries in which government intervention in the economy has waxed and waned. His conclusion? The evidence shows that more or less socialism has NOT been a major factor in determining stock market returns. It seems there are simply too many other factors with which it competes for it to have a major impact.  

This does not, of course, tell us with any certainty which stocks, sectors or asset classes are going to be the winners or losers in our economy and our country. Government policy-making activities will continue to combine with the other factors that result in stock pricing, which means the future will continue to be a big, fat unknown. In light of the uncertainty, I encourage my clients to continue building and maintaining globally diversified portfolios designed to track their individual goals and risk tolerances — and to continue to vote for whomever they feel will do the best job with all the rest.

Before we turn to the business of wealth planning, let’s have some fun. Quick, which square is darker, A or B? (If you need to, click here for a larger view.)

I was astounded (and initially skeptical) to learn they are identical colors! If you don’t believe me, click here for the demonstration of how contrast and shadows can bamboozle our eyes into seeing what simply isn’t there. (Incidentally, this is the same type of trickery that makes the moon seem larger on the horizon, even though we know it’s not.)

Clearly, you can’t always trust your instincts. It’s why airline pilots have to rely on their calibrated instruments along with the view in front of them. Turning to your wealth, it’s why it’s important to heed the academic evidence as much, if not more than, your intuitions about how markets and investing really work.

Consider, for example, a study published in the Journal of Consumer Research, “The Long and Short of it: Why Are Stocks With Shorter Runs Preferred?”¹ The authors demonstrated that investors preferred stocks whose charts display shorter “run lengths” (up-and-down movements) than those with longer run-lengths. Investors tended to perceive that the short-run-length stocks were less risky, regardless of the actual risk involved. Interestingly, the effect grew even stronger among those who were more highly educated and had more trading experience, i.e., those who thought they knew better. (Click here for additional information.)

Like it or not, our minds truly can play some sneaky tricks on us. When viewing Wikipedia games, that can all be in good fun. But when it comes to your wealth it’s serious business, and an illustration of why it’s important to focus on the investment “horizon” — your own long-term goals — rather than the illusion of individual stock charts.

One of the more fun parts of being a wealth advisor is when I get to remind a client that, really, much of the point of wealth management is to someday spend that wealth (or share it with others to spend). As hard as our riches sometimes come to us, it can be hard to shake loose of them, even when it’s okay to do so. Recently, I experienced some spending angst first-hand when I replaced my 13-year-old Mazda Miata (I love that car!) with a shiny, new Acura MDX.

I rather enjoyed the shopping experience, at least the part that didn’t involve plunking down my money. It was fun to pore over the catalogs and the actual cars on the lots. I liked exploring the options, test-driving the finalists, and narrowing it down to THE car.

The part that wasn’t fun was ensuring that we paid a fair price, without haggling and without spending too much time on it. My wife Šárka and I, being the methodical, financial planner/lawyer types that we are, devised a straightforward system that enabled us to pretty much eliminate the face-to-face negotiation with the dealer. Key components included completing some modest research up front, submitting my “request for proposal” to multiple dealers via fax, and narrowing my selection based on response. This helped me minimize actual dealer interface, since the price and specifications had already been settled before I met the dealer.

Click here to read my step-by-step process for buying my new car. Do you have a car-purchasing tip of your own? Share it here with me and others!

If you're a big saver and your significant other is a big spender (or vice versa), you might be surprised to learn that might have been the very trait that attracted you to them in the first place.  According to a paper written by Scott Rick and Deborah Small of the Wharton School of Finance and Eli Finkel of Northwestern University:

"Surveys of married adults suggest that opposites attract when it comes to emotional reactions toward spending."

Interestingly, it's been found that most single men and women state that they would actually prefer a mate with similar spending habits.  To read the full article, click here.

Does your retirement plan take inflation into account?  Since Vietnam, inflation has averaged 4.6% per year.  This may not sound like much, but since 1969 the purchasing power of a dollar has dropped by more than eighty percent.

Moreover, an interesting strand of economic research suggests that a retirement planner should also take into account "keeping up with the Joneses" - that is, spending even more in retirement to keep improving your lifestyle along with everyone else.  The historical rate of inflation, alone, understates the challenge investors face in funding a comfortable retirement.

If you're interested in a technical article that explains the details for you, read on...

International stocks are an important component of a well-diversified stock portfolio. Based on world market capitalization, sixty percent of a U.S. investor’s stock portfolio might be allocated to international stocks. A number of other considerations argue for reducing that exposure, however. While no fail-safe formula defines the best combination of U.S. and international stocks, the available evidence suggests that the traditional portfolio of 70% U.S. stocks and 30% international stocks has historically offered enhanced long-term returns with reduced risk, and probably is at least a well-reasoned starting point for most U.S. stock portfolios. To learn why, click here.

In this hour-long interview, Nassim Taleb, originator of the Black Swan hypothesis, argues that investors give too little weight to the risk of statistical “outliers.”  He says that the odds that unlikely events will occur are greater, and their impact is greater, than investors generally perceive.  Daniel Kahneman, well-known authority on behavioral finance, agrees with Taleb’s thesis but argues that the human need for certainty and security will prevent people from perceiving risk differently.  This conversation on perceived risk is especially interesting given the backdrop of the recent upheavals in global financial markets.  A personal note:  Once I got past the first ten minutes, I found the remainder of this hour-long interview intriguing.  The video offers, from an odd quarter, a point of view supporting my typical financial planning advice to avoid excessive portfolio risk and avoid or pay off most indebtedness.  It’s worth a listen if you have the time.  Click here for the video.