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Job One: Prevent the Big Mistake

For most investors, it’s a death sentence.

Carl Richards, 08/25/2014

This article originally appeared in the August/September 2014 issue of Morningstar magazine. To subscribe, please call 1-800-384-4000.   

In late 1999, a close friend of mine was set to sell his business and retire after 30 years of incredibly hard, but successful, work. As part of this process, he was debating what to do with the profit from selling the business. He took a look at how his different investments were performing to see where it made the most sense to put the money.

A portion of his portfolio included one of the now infamous technology funds. No surprise my friend’s investment was doing very well at the time. The other half of his portfolio was managed by a guy focused on value stocks, and it had performed poorly in comparison to his growth funds.

Convinced that the rally would continue, my friend had his advisor move all his value-based investments and the profits from selling his business into his growth funds. He made this move at the end of 1999. Anybody remember what happened to tech stocks only a few months later in March 2000? Even now, 14 years later, my friend, who was all set to retire, is still working.

Many investors can afford little mistakes, like using a small portion of their savings to try day-trading or buying a particular stock because their brother-in-law knows a guy who knows a guy. But my friend, who I know to be very smart, made what I call “The Big Mistake.” For most investors, it’s a death sentence and all but impossible to recover from.

Specifically, I’m talking about buying high and selling low. Few decisions can wipe out as many years of good behavior as fast as succumbing to this temptation. So, given the seriousness of The Big Mistake, I believe it’s an advisor’s primary job to prevent clients from making it in the first place.

I know that sounds like a huge task—maybe even an impossible one. But it’s what you signed up for when you opened the door to clients. Otherwise, how do you look that 50-year-old client in the eye after you say nothing when he begins heading down the path to his own Big Mistake? Of course, we can’t force clients to not go down that path, but if we aren’t using every ounce of persuasion we have to convince them otherwise, then it doesn’t really matter how many small mistakes we help them avoid.

Investors can do things like fail to rebalance on time, own a mediocre investment, or be a little tax inefficient. These are all mistakes people can survive and still reach their goals. However, it’s our calling as an industry to make sure we help our clients get the big stuff right. Much like a doctor’s oath to do no harm, the first thing you must do as an advisor is to help your clients avoid The Big Mistake for their lifetime. Even if that’s all you do, you’ll still have earned every penny they pay you!

For example, let’s pretend another time comes along that looks a lot like 2007, and a client says, “I think I should go all-in on real estate.” You don’t say, “Sure, that’s a great idea,” even though you’re thinking, “What a horrible idea.” Instead, you say, “I think that’s a Big Mistake and here are the reasons why.” Clients may not realize it at first, but they need their advisors to be a barrier between themselves and buying high while selling low. It’s time we accept this responsibility and commit to showing clients why it’s so important to avoid this temptation. Otherwise, there will be many more people like my friend, still working years after they thought they’d already be retired. That’s not acceptable to me, and I don’t believe it’s acceptable to you. We must first and always be the thing between our clients and The Big Mistake.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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