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The first secret: safety

Peter Hirsch | 6/7/2013, 11:07 a.m. | Updated on 6/11/2013, 11:21 a.m.
Last week we introduced The Seven SECRETS of Money Masters. Today we will begin with the first secret: safety.
Peter Hirsch Peter Hirsch

Last week we introduced The Seven SECRETS of Money Masters. Today we will begin with the first secret: safety.

Suppose we were to ask you, “What is the first thing you need to do in order to attain financial security and build wealth?” What would your response be? If you’re like most people, you’d probably say, “Earn more money and invest wisely.”

And you’d be wrong.

The first step in getting control of your financial life is ensuring that what you already have, regardless of how much or how little that might be, is protected. Many people are so focused on getting more that they forget to take the necessary steps to preserve their current assets until it’s too late.

Protecting your money is even more important than making more of it, because once you get behind, it’s very difficult to catch up. Let’s look at a simplified example.

Suppose you buy 100 shares of Widgets Inc. stock at $1 a share. During the first six months of your investment, Widgets’ top competitor introduces a hot new product and the value of Widgets’ stock drops by 50 percent. But there’s good news on the horizon. A few months down the road, Widgets comes out with an even hotter product and the stock doubles in value. Great, right? Not so fast. After the first hit, your stock was worth only $50, so your 100 percent profit only gets you back to your original $100. You’re barely breaking even. That’s why it’s important to avoid loss if at all possible, because once you’re in a hole, it’s very difficult to climb back out.

Investigate before you invest

Don’t make a move without taking the time and energy necessary to investigate the stability of the business itself, the person or people behind it, and the banks or other investors providing back-up at the next level. Remember that size isn’t always an indicator of stability. You have to look no further than the Big Three U.S. auto companies to see that even very large, seemingly stable businesses aren’t immune to devastating losses.

How volatile is the investment?

The stock market is a great example of extreme volatility, and yet 98 percent of financial planners have no qualms about putting their clients’ money, including their retirement accounts, into mutual funds despite the enormous risk involved. It should be illegal to have people nearing retirement exposed to full market risk. That is nothing short of financial malpractice.

We’ve all known people who have been sucked into investing large sums of money in the stock market based on tales of the huge profits being made by other investors. Around 1999, legends about dotcom millionaires and people who quit their jobs to find wealth as day traders, buying and selling Internet and technology stocks from their home computers, fostered the notion that the market was a modern day gold rush. We all know what happened next. As surely as night follows day, the dotcom bust followed the dotcom boom, and a lot of people lost a lot of money.

Then and now, it’s easy to find people who will tell you they can predict the market. Brokerage houses and investment advisors spend tens of millions of dollars on advertising, ensuring you that they have specialized knowledge that will protect your investments and make them grow. Financial programs on television love to trot out the latest wunderkind who has beaten the market and can tell you how it’s done.

Make a note of that guy’s name and keep watching. The chances are excellent that a year from now, he’ll have faded away and been replaced by someone else.

It’s much like betting on the Kentucky Derby. You can study all the available information about how the horses have done in previous outings on similar tracks, but past performance is just that – past. It can provide clues, but it is not an indicator of how the same horses will run today. There are no more reliable systems for predicting the stock market than there are for predicting the outcome of a horse race.

We’ll continue our discussion on safety next week.