Going Against Your 'Gut' Can Pay Off

BOSTON (TheStreet) -- Going with your gut is not always the smartest approach when it comes to financial matters. Instincts may serve you well in many areas of your life, but when it comes to saving and making money, the best moves are sometimes counterintuitive.

Staying in the game

One of the oldest cliches in the investing handbook is "buy low, sell high." It is certainly simple, sound advice. But even this ancient trope is goes against the grain.

Consider the Great Recession. People fled the market, leaping out of equities to the perceived safety of bonds and cash. With emotions running so high and headlines bemoaning one financial crisis after the other, it only made sense to jump ship, right? Even a cursory look at the history of market cycles, however, shows that it really shouldn't have taken a leap of faith to do the exact opposite, to stake your positions and stick to them. After all, if you can't "buy low" in the midst of a meltdown, when can you?

Because it's rare to have a prolonged (10 years or more) stretch when the market stays mired in a negative return, holding onto your stocks (as a generalization) will likely mean they rebound, gain and likely outpace inflation.

A post-recession study by T. Rowe Price(TROW) found that those who began to systematically invest in equities in severe bear markets were "significantly better off 30 years later than investors who began in bull markets." It was all the more true for younger investors benefiting from a decades-long time horizon.

The analysis charted four hypothetical investors who each contributed toward a retirement account that replicated the S&P 500 Index over three decades. Their starting date was set as coinciding with a severe stock-market downturn: 1929, 1950, 1970 and 1979.

The fictitious investors were initially hard-hit, but had the opportunity to buy at low prices, accumulating more shares for what would be coming bull markets. A 30-year investment that began in 1929 ended with a total gain of 960%; the investor who started in 1970 was up 1,753%.

Running from risk

Risk. The word is menacing and fraught with danger. For investors, however, it can be your friend, especially when properly paired with its mate, "return."

Repeated studies have shown that many folks fail to fully understand either their risk tolerance or the returns they need for future needs. Instead, as noted above, they follow the herd to perceived safety and the trade-off of low returns. Risk management in a portfolio is often overly simplified, revolving around a mix of stocks and bonds that shifts as your stomach for volatility shrinks.

Maintaining some degree of risk, however, even as one nears retirement, is important to ensure your money lasts for the ensuing decades. Proper diversification can even mean that some investment vehicles that seem "too dangerous" may have their role.

Striking such a balance is a lesson one can glean from how professionals craft such age/risk factoring investment products as target date funds.

"You certainly need to have a portfolio that generates growth through retirement," says Anne Lester, senior portfolio manager and head of SmartRetirement target date strategies for JPMorgan Asset Management(JPM). "But you need to think about a portfolio that can generate returns that are going to be less sensitive to the possibility of having two or three bad years in a row. If you are pulling money out of your portfolio, which again many folks close to retirement are, you really run the risk of having three bad years in a row -- and then your whole portfolio is derailed."

"One of the things we focus on as we build our target date funds is really this intersection of risk and return and trying to dampen downside volatility, or negative sequential volatility, through asset allocation and through using things that behave differently than equities to try to generate returns," she explains. "Things like high yield or other kinds of fixed income, like emerging market debt or things like that, can be risky compared to plain fixed income, but when combined in a portfolio that's focusing on risk management is less risky than just owning equities."

Better to give?

They say it is better to give than receive. That may seem contrary to the typical investment strategy, but sometimes it makes good financial sense.

In a recent interview with TheStreet, Eliot Brandy, CFP and senior vice president of Sun Trust Investment Services(STI), suggested that some may want to consider "a living gift" to beneficiaries, a move that can reduce the tax implications for all involved.

"Real estate values are significantly down for many of our clients," Brandy says. "It is a great opportunity this year and going forward to make gifts of assets that have depreciated in value, albeit you still have a gain in them. You may have bought your beach house for $1 million dollars, it got up to $3 million to $5 million and today it is worth $2.5 million. It may make sense to gift that home away from that perspective to save future estate taxes down the road -- which no matter how you look at it will be higher than the capital gains rates to your heirs."

Filter the advice

The complexity of modern investing, mixed with a degree of self-doubt, can make turning your back on advice seem unwise, ungrateful or stubborn.

We all have an inclination to heed the wisdom of those we trust, jump on those "hot tips" and formulate portfolio decisions while reading the daily paper or listening to talking heads bloviate. But neither the suggestions of loved ones and colleagues nor the temptation to chase headlines in search of returns and hedges may always be right for you.

"There are myths people act upon as if they were true, like you should never rent [instead of buying a home], you should never lease a car or that Social Security is never going to be there," says Martin Jaffe, co-founder of New York-based Silvercrest Asset Management, which manages about $10 billion in assets, and is board chairman for the National Endowment for Financial Education, a nonprofit national foundation that promotes financial literacy. "Different things become popular among people at different times."

Also troubling to him is what he calls "Saturday night investing," the whispered tip or overheard stock advice that drifts into social settings. It may be painful to pass up what sounds like a sure thing, but doing so is often the right move.
Parental guidance, when it comes to personal finance, can create an awkward situation for younger investors and be hard to resist. As much as they may want to respect their elders, taking their advice can prove problematic.

"Most of the time, they do what their parents say," Jaffe says of grown children hearing parental investment advice. "Their parents may be knowledgeable in a lot of things, but maybe not finance."

Even professional counsel should not be blindly followed, even if we've been raised to accept the word of experts.

Jaffe describes an investor who gets advice from two people, an accountant and a lawyer.

"What's wrong with that? Well the accountant is telling him he should find a tax shelter and the lawyer is telling him to buy mutual funds. You put them together and they may make sense, but neither of them is looking at the whole thing."

Personal finance needs to be "personal." One might have the overwhelming urge to pass off investment decisions or "set it and forget it." But being involved, informed and always questioning is as important as ever. Let your hired professionals do their job, but don't abdicate your own responsibility to ask questions, challenge assumptions or otherwise leave everything in their hands.