If you manage your own investments, changes are good you read dozens—if not hundreds—of articles every year offering advice on what to buy in your retirement portfolio. Most of the standard financial planning advice is, perhaps a little surprisingly, pretty solid. Ultimately, the size of your retirement portfolio is a product of the amount of money you are able to save over your lifetime and returns you are able to generate on those savings, which in turn depend on your asset allocation.
But unfortunately, most financial planning articles also leave a gap wide enough to drive a truck through: They give no guidance on what not to buy in a retirement portfolio.
Charles Ellis, a renowned investment consultant and an early champion on indexing over active management, famously called the stock market a “loser’s game” in that the average investor wins by not losing. As an example, Ellis likens investing to tennis. In a professional match, the player with the greater skill will generally win. But for the rest of us: “The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points.”
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- NFLX 15-Year Financial Data
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- Peter Lynch Chart of NFLX
Over the course of an investing career, we will all make mistakes. But keeping those mistakes to a minimum is the secret to “winning.” One big loss due to poor asset allocation can erase a lifetime’s worth of gains.
With that, let’s take a look at some asset classes best avoided in a retirement portfolio.
Short / Inverse Funds
Let me start by saying that there is nothing philosophically wrong with short selling. And in fact, I wrote an article at the beginning of this year listing several good short candidates for the bearishly inclined. (Momentum flameouts Netflix (NFLX) and Tesla Motors (TSLA) made the list, incidentally.)
Yes, you are betting against a company or, in the case of a fund, against a market, and that can have something of a deviant connotation. But short sellers also fulfill an important market function by adding liquidity to the market and in enforcing discipline on wayward company managements.
But just because you can short doesn’t mean you should, or at least not on a regular basis. And your certainly do not want to include a dedicated inverse or short fund in core retirement nest egg.
Think about it. The market has an upward bias, as it should. Over time, a growing economy should translate to higher revenues and earnings and higher stock prices. Since 1970, the S&P 500 has been up or flat in 34 of the 44 years, or 77% of the time. Do you really want to bet against those odds?
Absolutely. And if you maintain a more aggressive trading account in addition to your primary retirement nest egg, then I would argue that short funds are fair game there as well. Just keep ‘em out of your retirement portfolio.
Leveraged “Ultra-Bull” Funds
Ok, we know that the market has an upward bias. So, if the market rises over time, might it be a good idea to go for broke with a leveraged mutual fund or ETF, such as the ProShares Ultra S&P500 (SSO)—which offers double the S&P 500’s daily return—or the Direxion Daily S&P 500 3X Shares (SPXL)—which offers triple?
If leveraged funds offered to double or triple annual returns, I might be tempted to say “go for it” with at least a portion of your portfolio. Big down years—such as 2002 or 2008—would be devastating to your portfolio in the short term. But then, consistently doubling or tripling the market’s return in the vast majority of years that are positive should more than make up for it over an investing lifetime.
The problem is, the math doesn’t quite work out that way. You see, the leveraged returns are based on thedaily returns of the underlying index, not the annual returns. And the daily compounded returns of a leveraged fund will work out to a very different number than the annual compounded returns. For the curious math geeks out there, Investopedia breaks down the numbers here. And for a really geeky explanation, you can read what the CFA Institute has to say about leveraged funds here.
I can sum up the research with one sentence, however: If held for the long term, a standard 2X leveraged fund will generally give you double the risk in terms of portfolio volatility but significantly less than 2X the return. That’s a bad tradeoff.
My advice? Like short fund, limit your use of leveraged funds to your trading account. Keep them out of your retirement nest egg.
Gold and Precious Metals
Thankfully, gold has lost its luster as an asset class over the past few years. But before you write this off as another gold bashing article, hear me out.
I’m actually not opposed to gold ownership. I personally keep a decent stash of gold coins locked away…just in case.
Just in case of what you might ask? I have no idea, and that is exactly my point. At the risk of sounding like a gnarly-bearded backwoods psycho, you keep a small stash of gold for the same reason you own a gun. It’s a zero hedge in case the world as you know it completely fell apart—an extreme form of insurance.
But that said, gold is a terrible investment, and gold funds such as the SPDR Gold Shares (GLD)absolutely should not factor into your retirement portfolio.
Let’s assume that maybe—just maybe—the world doesn’t end. In a normal environment, the price of gold should, at most, roughly rise at the rate of inflation over the long term. And even this is by no means certain. Gold, unlike industrial commodities, does not get “used up.” Virtually all of the gold ever mined in human history, less that lost to shipwrecks, is either currently used for jewelry or locked away in a vault, and new gold is mined daily. For the price of gold to rise over time, demand has to outpace a constantly growing supply.
But more fundamentally, gold does not pay interest…nor does it have earnings to distribute as dividends. It’s nothing more than an attractive ornamental metal, and you’re ability to profit from it depends entirely on your ability to sell it to someone else at a higher price.
Gold will not pay your bills in retirement—and gold has no place in your retirement portfolio.
About the author:
Mr. Sizemore has been a repeat guest on Fox Business News, quoted in Barron’s Magazine and the Wall Street Journal, and published in many respected financial websites, including MarketWatch, TheStreet.com, InvestorPlace, MSN Money, Seeking Alpha, Stocks, Futures and Options Magazine, and The Daily Reckoning.