When Better is Worse

Apr 5, 2017

Here’s a recent headline from the Wall Street Journal – Individuals Tiptoe further into long running stock rally.

Is that you? Maybe you’ve done very well in your 401K this year. But you’ve also got that money in your savings account you put back for a rainy day. And it’s just sitting there.

It’s my emergency fund, but it’s earning next to nothing. Maybe that’s an emergency! Shouldn’t I find something more productive to do with that money? Maybe one of those growth and income fund?

OK Stop!

What kind of car do you drive?

I don’t care what your answer is, it’s nothing compared to the Chevrolet Jimmie Johnson drives. Last November, Jimmie drove his trusty #48 car to victory at the Homestead-Miami Speedway for a record-tying seventh NASCAR Sprint Cup championship. He drove 400 miles at about 150 miles per hour to win first place.

I used to drive a Chevrolet (Suburban). By the time I sold it, it was almost old enough to vote. Not only did it not go 150 miles per hour, I’m not sure it ever went 150 miles on a tank of gas. Should I call Jimmie to see if he’d be willing to make me a deal on his used Chevy?

The silliness of his illustration makes its own point.

But when it comes to something as abstract as money, it’s easy to drift into this kind of thinking. I call it the danger of over-optimization.

The myth is that bigger is better.

The reality is that usually balance is better. A myopic focus on “bigger” eventually gets you into trouble (housing bubble, debt crisis, credit card debts, college costs…did I leave something out?).

Wall Street spent a generation telling us that rate of return is where it’s at. The higher it is, the happier you’ll be (or so the story went).

Until the reality of risk showed up and everyone started listening to that deep voice intoning at the end of all the mutual fund commercials, “Past performance is no guarantee of future returns.” Now you tell me!

Does that mean we should abandon investment opportunities which include an element of risk? Not at all. But it does mean we should approach such risk-bearing opportunities with our eyes wide open and our balance sheets…balanced.

Emergency funds are for what the name implies – emergencies. And by definition an emergency is (a) something bad, and (b) that takes you by surprise. Investments and surprises usually don’t mix well together. A part of your net worth needs to be made up of highly liquid accounts (I like cash!) whose main purpose is ease of availability in the event of emergency.

About six months worth of your annual income is what I would recommend.

Don’t have that much cash in the bank? Then you’d better get a move on…at a nice, steady pace of course.