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Be Wary of Investment Guarantees

GuaranteeThe prospective client interviewing me was nervous and skeptical. She insisted on some type of guarantee that, if she hired my firm to manage her investments held for retirement, we would make her money.

I asked her what she meant by “make her money.” She said that her balance would never go down. “No, I can’t guarantee that,” I said.

“How about if it doesn’t go down at the end of any year?” I again said no. “How about at the end of three years?” No. “Five?” “No. I can’t give you a guarantee.” “How about ten years? Can you guarantee I will make money over ten years?”

Finally, out of frustration, I succumbed. “Okay, I will give you a guarantee.” A puzzled look crossed her face. “I will guarantee you that at times we will lose you money.” The interview wrapped up shortly after that, and she never became a client.

Looking at the situation from her perspective, who could fault her for walking away? Can you imagine a hypothetical conversation with a friend who might ask how her interview went with the investment advisor? “Oh, he would only guarantee me that he would lose me money.” Who in their right mind wants to hire that investment advisor?

While my comment may have been a bit brash and tactless, it was still true. If making money means a portfolio will never decline, then I’ve lost clients and myself a lot of money over the years. Any portfolio, even one invested in a diversified array of asset classes, will fluctuate daily. Portfolios peak and fall. Rarely do they ever plateau, at least not for long. Peaks are inherently unsustainable, just as are valleys.

Long-term investment progress often can look like taking three steps forward, four steps back, six steps forward, and four steps back. That’s a lot of steps back and forth to have gone one step forward!

The only way I know to be guaranteed your portfolio will go up in value every year and never decrease is to lend your money to a bank through savings accounts or certificates of deposit. However, you must keep any account under $250,000 to qualify for the government guarantee. Any amount over that could be lost if the lending institution fails.

That’s it for guaranteed investments. No other investment vehicles—bonds, stocks, annuities, retirement plans, deferred compensation plans, or cash value life insurance—come with an ironclad guarantee that you will never lose any of your principal.

So if good investors are guaranteed to lose money, what will great investors do? While they will also lose money over the short term, over the long term they will do just average. “Average” here is defined as equaling an index return. If equating “great” and “average” sounds like an oxymoron to you, consider that over a twenty-year span, 97% of investors don’t obtain an average (index) return. As I have said before, investing is the only competitive sport where being average puts you in the top 3%.

A good money manager or investor with an eye on the long term will almost always lose money. Guaranteed. The manager may be a personal investment advisor, a bank trust officer, the CIO of an institutional pension fund, or a mutual fund manager. If they are good, they all will eventually lose money.

I know of only two types of investment managers who makes money year after year. One type only talks about their winners and conveniently forgets their losers. The other type runs Ponzi schemes. Ethical investment advisors cannot guarantee you will never lose money.

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