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NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.

A few weeks ago I did a post on the value of investing in gold.  I was a little surprised by some of the responses that I received.  It was almost like the responses I get when discussing abortion, truthers and birthers.

This graph created by John C. Bogle and is in his book “Common Sense on Mutual Funds (2010).  It shows the returns for several investment classes from 1802 to 2008 in real dollars (real dollars are after an adjustment for inflation) (note2: The total return is a log scale).  John C. Bogle is the founder of Vanguard and is recognized as one of the greatest minds in the investment world. Mr. Bogle also had this to say about gold…

”  …gold is largely a rank speculation, for its price is based solely on market expectations.  Gold provides no internal rate of return.  Unlike stocks and bonds, gold provides none of the intrinsic value that is created for stocks by earnings growth and dividend yields, and for bonds by interest payments.  So in the two centuries plus shown in the chart, the initial $10,000 investment in gold grew to barely $26,000 in real terms.”  Common Sense on Mutual Funds(2010), Page 13.

With this additional support, I stand by my position that gold is not a good long term investment.

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NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you do need help with your investments contact us – Polaris Financial Planning.

I have had a lot of people ask me about investing in gold, silver or other commodities.  Gold in particular has gone from $513 an ounce at the end of 2005 to almost $1,500 as of today.  This type of rapid increase (and lot of advertising) can get people real excited.

I am not a big fan of “investing” in commodities.  Over the long run they do not give great returns.  Don’t get me wrong, I think that gold, like all commodities tend to go up over long periods of time time but it is nothing close to the returns of stocks. If you really want to put 5-10% of your money into something like this, I guess it would be fine but, why would you do it after the price jumped 200%?  People can sometimes lose their reasoning skills when thinking about investments so I like to use real world examples for comparison.

Let’s say you are in the store looking to buy some jeans.  You find the perfect pair but they cost $100.  You think that is a little high so you decide not to buy at this time.  A year later you find yourself in the same store and see that the same pants are now $200 – so you buy them!  Of course, most people would not but the jeans for $200 but, this is often how think about investing.

“It just went up a lot – I must buy it”

I would never try to guess if a given commodity (gold, silver, oil etc…) will go up, down or sideways during a given day, month or year.  However, a rapid increase in price is often followed by a correction.  I do not have any interest in the current down side potential in gold. Take a look at the graph below.  The last big run up of gold was 1979 and 1980.  Gold went from $200 to $600 an ounce.  An increase of 200% in just 2 years.  If you bought gold for $600 (or more) per ounce in 1980 you had to wait until 2006 to get your money back.  26 years just to break even – that is a very long time.

I love playing with graphs.  Here is one that shows the performance of gold and The Dow from 1980 to 2010.  Do you sill think gold is a good long term investment?

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NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you do need help with your investments contact us.

Some content and ideas are taken from the Center for Behavioral Finance.  The use of this content is not intended to be an endorsement of the Center for Behavioral Finance or Allianz Global Investors.  It is used as a framework to facilitate discussion on this important topic.

I am always a little worried when an investment company talks about how to work with investors.  I always worry that they are focused on selling product and not actually being helpful.  While I don’t agree with everything in this report from The Center for Behavioral Finance some of the content is very useful.

TWO MINDS….

Kahneman uses the framework of “two minds” to describe the way people make decisions (Stanovich and West, 2000). Each of us behaves as if we have an “intuitive” mind, which forms rapid judgments with great ease and with no conscious input; “knowing” that a new acquaintance is going to become a good friend on first meeting is one such judgment. We often speak of intuitions as “what comes to mind.”We also have a “reflective mind,” which is slow, analytical and requires conscious effort. Financial advisors engage this mind when they sit down with clients and calculate a retirement framework based on their risk profile, current circumstances and future goals.

For this discussion the  Two Mind concept  kinda works when describing some of the behaviors of investors.  First is this comment about the “intuitive” mind.

At the core of many of these powerful but erroneous intuitions is people’s hyper-negative response to potential loss, or “loss aversion,” as described by Prospect Theory (Kahneman and Tversky, 1979). Simply put, losses loom larger than equal-sized gains.

I have seen this many times.  People will buy very bad and complicated products just because they think it will keep them from loosing money.  There are always risks with investing.  If you lower the risk – you will likely lower the returns.  If someone tells you that you can make high returns with very low risk be very careful.

This Warren Buffet quote show us the “reflective mind”.

“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

One of the reason I like Index funds is that they take away some of the anxiety of when to buy and sell stocks.  The full length version of the  Behavioral report had this great study.

A separate study of transactions in 19 major international stock markets produced equally salutary warnings against the urge to beat the market by too frequently buying and selling securities. Between 1973 and 2004, the average “penalty” for repeated buying and selling as opposed to a buy-and-hold strategy in these markets was 1.5 percent (Dichev, 2007).

The vast majority of investors lose money by trying to beat the market.  It cannot be said enough times – use a buy and hold strategy and use ultra low cost index funds.  If you don’t know how to do this you will be well served to hire a financial advisor.