There’s No Free Lunch: Lim Part II

by Dual Income No Kids on July 27, 2006 · 0 comments

Yesterday, we outlined the first few chapters of Paul Lim’s book, “Money Mistakes You Can’t Afford to Make”. By way of our second posting in this series, we wanted to briefly describe Lim’s views on risk and investing as he outlines in Chapter 4 and 5.

Chapter 4 details risk. Specifically, Lim discusses investment returns since the market crash in 2000. According to him, the only way to manage the kind of volatility the market has demonstrated is to do the following: 1) manage your time horizons, 2) manage risk (company, market, sector, political/country risk, asset type, and credit risk). Finally Lim’s bottom line is that ‘There is no such thing as a free lunch”, e.g. that all types of assets come with risks. The key is to diversify to better manage risk.

In terms of our management of risk, Miel and I have a variety of assets. For example, we have real estate, savings bonds, alternative assets like precious metals, as well as stocks and mutual funds. Unfortunately, all of our real estate is in Washington DC, and all of our investments are in the U.S. Although our asset allocation could be improved, its safe to say that the benefits of diversification are far from universally accepted.

Chapter 5 discusses the interaction of investor psychology and diversification. It’s been Lim’s experience that investors tend to chase “hot” investments. The example in the late 1990s tech was a “must have” sector. He notes that performance chasing alternates between kinds of investments and (e.g. stocks v. bonds) within types of investments (e.g. large v. small cap stocks). The way to get around this is to base your asset allocation on one’s individual financial goals and needs, rather than on performance.

For the everyday investor, this is sound advice. However, once in a blue moon, there are some opportunities which are hard to pass up. Sometimes, it’s fair to heavily focus one’s assets to maximize ones investment return. For example, my father knew a gentleman who, during the high inflation period of the 1970’s sold his house to buy U.S. treasury securities yielding 18%. During the late 1990’s those bonds would be worth a great deal while carrying, little if any, risk of default.

Lim has more say about investing, but these will be discussed in a later posting!

Best,

James

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