What the big bank’s disaster means for small investors?
Back in the darkest days of the financial crisis, J.P. Morgan was praised as one of the few large financial institutions that exhibited caution when the rest of the industry dove headlong into exotic derivatives that nearly blew up the global economy. So it was a great surprise when the company recently announced a trading mishap that could cost the bank and its shareholders upwards of $10 billion.
Many lessons can be learned from the company’s mistake, but among the greatest are those for investors who hardly have billions to put at risk. In an age where financial security seems scarce, bulletproofing your own portfolio allows an investor to take their future into their own hands.
That doesn’t mean you need to be a financial pro or run off and get an MBA. Instead, you need to evaluate your own skills, your financial needs and define a financial strategy accordingly.
In doing so, you can protect the type of missteps that turned J.P. Morgan’s from praiseworthy—to blame-worthy—overnight.
Know your holdings
Imagine walking into your local box store and seeing a plain cardboard box with a $100 price tag. People stand around and admire it. You pick it up—it feels heavy and substantial—so you figure why not take a chance and buy it. Who knows what could be inside? You take it home and open it, only to find it’s piled with cinder blocks.
Sound absurb? It is, perhaps, but it’s the type of blind faith that many investors exhibit every day. Drawn by the promise of riches, and fear of losing out on something others seem to value, you buy a pile of stock with little sense of it’s inherent value. It’s a surefire way to lose, particularly in the long-term.
The best way to protect yourself from such investing pitfalls is simple to explain, but difficult to implement: know what you’re buying before you buy it. One of the most puzzling aspects of J.P. Morgan’s losses is that they seem to derive from the very complex securities—credit derivatives—that its brethren gorged on in the run up to the crisis.
And those are the supposed experts. Conduct a strict analysis of your own investing skill and decide whether it makes sense to pick your own stocks. Humility is a virtue. When reporters asked J.P. Morgan chief Jamie Diamond about rumors about a sizable trading loss, he called it a “tempest in a teapot.” A few weeks later, he came forward to explain that the tempest had, well, left the teapot. It not hard to imagine how Diamond would have handled the situation, to the benefit of the firm and its shareholders, if he hadn’t relied on his high-opinion of the company and accepted the possibility of mistakes.
In doing a thoughtful self-analysis, you may very well find that you lack the time, discipline or skills necessary to perform the fundamental analysis necessary to make considered investment decisions. If you have the money, hire a professional financial advisor (their occasional missteps notwithstanding). Ask your friends for a referral, or seek one out that charges by the hour rather than receiving their income from commissions on products they sell. It’s a good idea to find one with a credential like Certified Financial Planner (CFP), which indicates a certain level of training and commitment to the profession. It’s not everything, but it can’t hurt.
If you want to save money or don’t have access to a good advisor, keeping your accounts invested in index funds, across several asset classes, is always a good bet. It’s a rare money manager who can consistently beat the major benchmarks—investing directly in those benchmarks gives you broad diversity and the peace of mind that comes with keeping up with the broader investing world. In addition to index funds, look at exchange-traded funds, which are designed like mutual funds but trade like stocks. They are more liquid than mutual funds, which trade at the end of every trading day, and sometimes come with lower fees. You will, however, typically pay a commission on the trade.
Make a plan and keep to it
It appears that one of J.P. Morgan’s mistakes was taking a trade that was originally meant to hedge against other losses in the portfolio and instead expanding it to make money on its own. Avoid the same circumstances by mapping out and investing plan that easy to stick to, and don’t deviate from it.
Of course, you should reevaluate a few times a year as economic circumstances change, but a broad outline will help prevent the emotional buying and selling that plagues many of us. And keep in mind that no matter how dire the current situation may seem. Most of us should be buy-and-hold, long-term investors. It’s the aggregate, not isolated or ephemeral events, that matters. When things seem perilous, perhaps you should be buying Instead of selling.
One good approach to keeping your impulses in check is to establish high and low thresholds for buying and selling—sell when a holding appreciates 15 percent and buy more when it depreciates 10 percent. If you’ve made the right investment decision up front, you’re guaranteeing that you’ll buy low and sell high.
There’s no simpler, better—or more neglected–way to make money than that.
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Matthew Malone is a staff writer for RothIRA.com, a leading retirement and Roth IRA resource. Matthew is also a contributing writer to CBS SmartPlanet. His work has appeared in The New York Times, Cosmopolitan, Smartmoney.com, Fortune.com, Forbes.com, and other publications.