How to invest money from the sale of a ranch – part two
In my experience, ranchers often play it too safe with their investments. I have asked families who sold their ranch and deposited all of the sale proceeds into Certificate of Deposits (CDs) why they chose to do so.
Their response is typically, “I need to know my money is safe.” The irony is while CDs are safe from market risk, they can expose ranchers to one of the greatest risks, which is either running out of money or facing an ever-decreasing standard of living.
Cash is the worst performing asset class in history. Over long periods of time, cash, which includes CDs and money market accounts, generates a negative return after subtracting taxes and the rate of inflation.
A much better option for providing retirement income is to invest in a broadly diversified portfolio of low-cost, index mutual funds. Age, rate of return objective and tolerance for risk will dictate the percentage of money allocated to equities or stock funds and fixed income or bond funds.
For many retiring farmers and ranchers, an allocation of around 30 percent to 60 percent in equities is appropriate.
Active management versus passive management
While there are many different products and strategies for investing in the stock and bond market today, there are two basic investment philosophies ranchers should be aware of. These include active management and passive management.
Active management tries to outperform stock market and bond market indices using several techniques, such as market timing, stock picking and sector rotation.
Passive management, on the other hand, doesn’t attempt to outperform the stock market. Rather, it attempts to capture the returns of the market by investing in a fund mirroring a stock or bond market index.
Passive investors don’t try to predict future movements in security prices. Instead, they adopt a long-term, buy-and-hold investment strategy, focusing on broad diversification and keeping costs low.
The assumption of underlying active management is financial markets are not efficient. This means some assets will inevitably be overpriced, while others may be underpriced, and it’s possible to buy the underpriced ones and sell the overpriced assets at opportune times.
The truth is, markets are very efficient and consistently beating the market over long periods of time is almost impossible to do.
The brokerage industry and financial media often promote the idea that outperforming the market is possible if one can find the right stocks within the right sectors and get in and out at the right times. Wall Street pundits like to believe their advanced investment acumen, combined with experience in stock picking, can achieve above average performance. The research, however, points otherwise.
A study was recently completed which analyzed the performance of activity managed mutual funds. The study compared the returns of these funds against a passively-managed index. From 2000 through 2018, only 17 percent of stock funds succeeded in beating their benchmark index.
Bond funds performed even worse. The outcome of this study is strong evidence beating the market with active management is very difficult.
Annuities
Annuities are investments offered through insurance companies which can be used to accumulate money on a tax-deferred basis and to provide a contractually guaranteed income for retirement or other purposes.
While I believe annuities can play a part in an overall diversified investment portfolio, I am of the opinion, and so are most independent, fee-only registered investment advisors, an investor is better off creating a portfolio of low-cost mutual funds or exchanged traded funds.
Annuities may seem like a wise investment, especially in times of high market volatility, but they often have significant drawbacks which aren’t often readily apparent or disclosed. Annuities can be very complex with many moving parts, confusing restrictions for obtaining benefits, and they can be expensive to own.
Alternative investments
Alternative investments include such investments as hedge funds, private equity funds and commodities. A common reason given for owning these types of investments is they provide the opportunity to improve a stock and bond portfolio’s diversification while reducing volatility.
Proponents claim alternative investments are good diversifiers because they have low correlation with traditional stock and bond investments. Just because an investment may have low correlation with the stock market doesn’t justify owning it.
Alternative investments typically have much higher fees than mutual funds and exchange-traded funds. They tend to be riskier investments as well, often using large amounts of leverage or borrowed money, making concentrated bets on asset classes or sectors and trading excessively.
And, while alternative investments are subject to less regulation, they also have less opportunity to publish verifiable performance data.
There is little evidence alternatives have higher returns than traditional asset classes such as stocks and bonds. My belief is an individual does not need to invest in alternative investments.
Given their high costs, lack of diversification and insufficient liquidity, one is better off sticking to a properly diversified portfolio of low-cost mutual funds or exchange-traded funds.
Chris Nolt is an independent registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement. To order a copy of Chris’s new book, Financial Strategies for Selling a Farm or Ranch, visit amazon.com or call 800-517-1031. For more information, visit solidrockproperty.com and solidrockwealth.com.
