Advice based on risk but not net worth doesn't cut it

I was listening to a radio show recently, and the caller was debating with the host the fact that while he held mutual funds, he had also invested in stocks over the last 10 years. Given that I have been writing several articles about net worth lately, I felt particularly attuned to the lack of attention to net worth. When the host asked how much he had in savings, the caller answered $96,000. When he next asked how much he had in the stocks, the answer was $47,000.

The host immediately went on the war path. He slammed the caller for having a broken risk meter. He asked the caller if he really thought he was going to "beat the odds." He told him he was playing with fire. The fact that the caller had bought some tobacco stocks because people haven't stopped smoking was dismissed as a frivolous strategy. The host indicated he probably knew more about stock investing than the caller, and that he flat out didn't hold any single stocks. The call kind of ended there. I was a bit stunned!

Can you spot the rights and wrongs amidst all this?

First of all, the focus of the host was all about risk. The fact that the caller's total net worth was just shy of $100,000 never entered the foray of discussion. The host chewed him out for buying stocks (making good on-the-air schtick), but didn't get on his case for simply not saving enough. The Federal Reserve bulletin which comes out every three years shows that the average person in their mid 50s has around less than $60,000 in retirement savings (page 28), which is way low for building a retirement plan. The caller was a little better, but not much. Considering he had been investing in stocks for at least 10 years means the caller must at least be in his mid-30s. The fact that his net worth was way low for a good retirement was flat out not covered. The caller doesn't seem to understand the truth about net worth and the reason we need to build up a portfolio of performing assets.

From there, the conversation went downhill. The host of the show berated his caller for basing stock buying decisions on what products are commonly used. The caller clearly knows that tobacco products aren't going away anytime soon. In fact, the most successful investors of our day, including Warren Buffet and Ben Graham, preach that we should only buy companies we truly understand. If you look at all the products you use for your morning routine, you may spot things that millions of other people are using every morning as well. This leads to some potential stocks that deserve additional research and analysis to consider for purchase. While the host was correct that study after study shows people can't beat the averages in day trading, buy-and-hold over the long term has been shown to succeed and build wealth, if you know what you are doing. As Warren Buffett says, "I buy on the assumption that they could close the market the next day and not reopen it for five years."

The host said this guy had too much in stocks. That is something I agreed with. But the host implied that the answer was mutual funds. People buying mutual funds have a long term average performance of less than 4% annual growth. Not good enough! This caller needs something with a better, long term, double digit growth factor. The answer is investment real estate. It allows us to use safe amounts of leverage while taking advantage of some of the best tax laws on the books. Over the long run, real estate typically has a better appreciation rate than stocks. But don't base your analysis of a piece of rental property on appreciation. Instead, base it on no appreciation and no increases in rent. If it's in a good location and built with good quality, then you may be closing in on an opportunity. The less deferred and potential maintenance the better.

I'm sure if the caller had mentioned the idea of real estate backed by debt, the host would have shot that down in a heartbeat as risky and especially dumb when debt is brought into the picture. There definitely is risk involved, but that's not reason to drop the whole idea. Instead, we need adequate cash reserves to mitigate this risk. There WILL be vacancies, repairs, and other costs to deal with, all which require a certain amount of easy-to-reach cash. Assuming Murphy will make an appearance and planning to deal with that will let you sleep at night.

The fact that the host was driven by risk and didn't discuss net worth tells me he is imbuing his callers with a fear-based investment strategy. "Go for mutual funds. They are your best tradeoff because they let your money grow faster than CDs yet protect you from the total brunt of market corrections." Okay, the host didn't say that, but he might as well have. Fear isn't enough to build a retirement plan. The diversity of mutual funds may protect you from certain losses, but even worse, they also protect you from recoveries even more. 

In the math of losses and gains, you need gains bigger than your losses to get back to where you started. 20% loss requires 25% recovery to get back to where you started. 50% loss, 100% gain. We call that stacking the deck against you! Instead of wasting your time searching for the right mutual fund, find someone who is skilled at pursuing rental property and has a proven track record of building net worth for their clients. That is something that will, in wealth building lingo, cut it.