Playing It Safe

Investors often think of conservative versus aggressive as a discussion about their investment portfolio weightings. The more conservative investors put a larger percentage of the portfolio in fixed income. Aggressive investors favor equities. But today we are going to discuss an entirely different meaning of the word conservative. That is, we are talking about the behavior conservatism.

Conservatism means you prefer to keep things on the safe side. You favor things that are familiar over the new and uncommon. The dictionary definition of conservatism is this: commitment to traditional values and ideas with opposition to change or innovation.

This is seen inside investment portfolios when you take a greater position in your home country, industry, or company stock. The familiarity of the investment makes you more comfortable, as it is what you know. Unfortunately, those good feelings can have consequences. With too much of an allocation to one country or company, you may not be as diversified as you thought you were.

Another sign of conservatism is when you opt for the default 401(k) choices your employer gave you. Auto-enrollment features may have you contributing just 3% of your paycheck to start. You won’t be happy with your retirement outlook if you stick with that option.

Want to avoid falling into the traps of conservatism? Use these easy to implement systems to help ease the tension of something new:

Invest across the world. As I mentioned above, a portfolio with home bias won’t be as diversified as you need to be. It is easier than ever to invest your portfolio across the world utilizing low-cost index funds. Mutual fund companies also have all-in-one funds that provide you with a fully diversified portfolio that is rebalanced for you. You can also use international funds to offset the exposure to your home country.

Use the auto-increase feature on your retirement account. Are you saving just a small amount of each paycheck, yet can’t get yourself to contribute more? Your 401(k) plan may have an auto-increase feature that increases your contribution for you by a predetermined amount at a set time in the future. A 1% auto-increase once or twice per year will get you headed in the right direction.

Buy the unfamiliar. One of the most common tips for investing I hear is “buy what you know”. It was coined by the famous investor Peter Lynch. Investing is much more complex than simply purchasing shares of Apple just because you see all of your friends own an iPhone. Humans tend to feel they are taking less risk investing in a company that is familiar. This approach can leave your portfolio with overly concentrated positions. Instead, make sure you are investing in companies, industries, and countries that are “foreign” to you.

Take your time. A simple way to remove conservatism is to reduce the number of impulse decisions you make. That’s right--procrastinate. I give you permission. You are more likely to favor the familiar when you have to make an impulse decision. This may be when offered an “exclusive” investment opportunity by your friend or when choosing a health insurance plan during open enrollment. Evaluate your options and make a less pressured decision.

Prepare for the worst case scenario. Have your financial foundation in good order before you take on risk in your investment portfolio. My philosophy is that money that goes into an investment account is there to stay. For a really long time. In order for that to happen, you first need to build up your emergency fund and pay off consumer debts. If you have to dip into your investment portfolio to pay for short term needs, you can lose the main benefit of investing: compound interest.