Four Ways To Ruin Your Investments – Guaranteed

This is a guest post by Neal Frankle, a CFP and author of Wealth Pilgrim. If you like what you see here, please consider subscribing to his RSS feed.

Imagine that you just heard Jim Cramer talking on CNBC about a “guaranteed” way to make a fortune with your investments. Upon hearing this, you have three choices:

  • Refinance your house so you can invest everything possible
  • Call your financial adviser and ask her what she thinks about it
  • Change the station to Spongebob Squarepants

What would you do?

If you said you’d change the station, you made the right decision. Nobody can guarantee how an investment is going to work out — not even Jim.

If somebody tries to sell you a far-fetched story, you might as well get some animation along with it… You’re better off with Spongebob.

While I can’t give you a guaranteed way to make a fortune, but I can guarantee that you’ll ruin your investment portfolio if you make any one of the following four financial mistakes.

Shifting your timeframe

Anytime you want, you can “prove” that an investment is either great or terrible. All you have to do is shift the period over which you do your analysis.

For example, if I ask you if stocks are a good investment, you might say, “Are you nuts? Do you live under a rock? No, they are a terrible investment. I lost 40% of my money last year!” You might even tell me that you lost a compounded 2% over the last ten years – further evidence of how bad the stock market is.

On the other hand, you might point to the fact that the last ten-year period was one of the worst ever. Instead of looking at the last ten years, you might consider the average ten-year return, which is close to 10%. Or you might point to a twenty-year average and “prove” that the stock market is pretty darn good.

So which is it? Good or bad?

All of the facts are right. The issue is which set of facts you decide are relevant to your timeframe, and whether or not you stick to that timeframe.

My point here is that, if you make an investment based on a twenty-year timeframe and then decide that you made a mistake because last year was very bad, you’re almost guaranteed to fail.

Why? Because market investments are extremely volatile, and good results can take time. If you jump out as a result of a terrible period, you won’t be in during the recovery. Congratulations — you’ve just locked in your losses.

Have you ever bailed on an investment because the pain was just too great? Investors often say they understand that investing is a long-term proposition — until they find themselves being tortured by horrific losses day after day. At some point, human nature takes over, and they bail because they’ve changed their time horizon.

Trying to predict the future

You may have run across people who think they can do this. Perhaps you’ll see some genius on TV make a prediction that later comes true. Just remember that this fortune teller won’t tell you about all the times he/she got it wrong in the past. After all, even a broken clock is right twice a day.

You might think that you never try to predict the future, but let’s take a closer look…

Have you ever jumped on a hot stock because you knew it was poised to break out? Or scooped up a “bargain” because you just knew it would never fall back to this level? If so, you’re guilt of trying to predict the future. Think of the times that you’ve done this. What were the results?

Wanting to have your cake and eat it, too

Have you ever complained about about the low interest rate on your savings account or CDs? The reason for the relatively low rate on these instruments is the inherent trade-off between interest rates and security.

If you want short-term security, you have to accept low (but guaranteed) interest rates. That’s just the way it is.

If you’ve ever complained about lousy stock market performance, you’re guilty of the same thing… The higher the expected returns, the greater the risks. This translates into the potential for wild price swings and extended down periods.

If your only problem is that you like complain about such things, you might ruin some relationships, but your investments should be safe. The problem is that many people expect great returns and security. These are the same people that fall for some slick sales pitch and get their heads handed to them. Remember Bernie Madoff?

Being unclear about your goals

By far the best way to run your investments into the ground is to be fuzzy about your goals.

“Hold on Neal, ” you might be saying to yourself. “My only goal is to make money — that’s why I’m reading this post. You’ve been watching too much Sponge Bob!”

I’ll admit that I do have a weakness for that cute little yella’ fella’, but I’m dead serious about the importance of being clear about your goals. Let me give you an example…

You might say that your goals are to retire and never have to worry about money. Fine. Let’s say you could invest conservatively and have a high-probability of achieving your goals. That being the case, how would you invest?
Conservatively of course.

But there will be times when you might be tempted to take advantage of a “special” investment opportunity — a “sure thing” that turns out to be a high-risk proposition that threatens your goals.

You’d be far better off letting your goals be the lens through which every investment is examined. People often forget about this and as a result get involved with investments that expose them to undue risk and (often) investment failure.

Have you ever committed any of these mistakes? What were the results? Have I missed some other major source of investment catastrophe?

22 Responses to “Four Ways To Ruin Your Investments – Guaranteed”

  1. Anonymous

    Many good arguments and well made.

    I’d have to argue that the stock market is a great alternative for long-term investment goals and a horrible one for short-term goals. Yes….it’s great but not perfect.

    Many look for the silver bullet and it doesn’t exist IMO. You can do everything right and the universe may conspire against you. That doesn’t mean you made a mistake.

  2. Anonymous

    Nickel & LOL–Agreed that long term the market rises, but LOL made the point that if your time horizon is short, or you don’t save much, the stock market is the better option because of higher returns. I still disagree. The market rises over time; the shorter the time span the less reliable the rise. The returns are never guaranteed, and the person with less time or money has less margin for error.

    Yes, you have a greater need for higher returns with a shorter time horizon/less money situation, but the market won’t cooperate just because we have needs. Most financial planners will tell you to reduce your exposure to stocks the closer you are to needing the capital invested, which is sage advice.

    My comment “it’s almost guaranteed you’ll get a big loss instead” was tongue-in-cheek, which doesn’t translate in emails unfortunately. But it serves to highlight that the more we NEED something to happen, the less likely it is to happen, and it might even go the other way.

    Our needs can affect our direction and decisions, but they have no bearing at all on the outcome of an investment vehicle as impersonal as the stock market.
    A person with great short term needs, who invested his small pile in the market in 2007 would have a lot of wounds to lick right now. That’s an extreme example of course, but real life can be that way.

    Does that make sense?

  3. Anonymous

    Nickel: another option would be TIPS (treasury inflation protected securities) — basically any investment that grows (at least) with inflation, with no / low risk. So, I am not ignoring the inflation aspect — I did not say to invest in Cash for example.

    Also, the stock market has ‘historically’ increased on average — but that does not mean it will continue to do so into the future, and it absolutely does not mean it will even keep pace with inflation.

  4. Anonymous

    Kevin: In regards to the 59-year old who has not saved enough. So, is it a NEED, or a WANT? Because if you ‘need’ the money in the short-term timeframe, your only option may be to be reckless / risky (stocks), because at least you have a chance — being conservative would actually be the riskier choice since there might be a 100% chance of not meeting the goal.

    You are suggesting that it is not a NEED, and instead modify the goal (work longer, reduce lifestyle in retirement) — which, of course is an option — but that also means you do not ‘need’ the money in the short-term timeframe.

    I agree with Neal Frankle completely when he said: “You’d be far better off letting your goals be the lens through which every investment is examined. People often forget about this and as a result get involved with investments that expose them to undue risk and (often) investment failure.”

    People should really absorb and understand what he is saying there, because that is a gem.

    I think retirement (or savings) goals should be divided into two parts: the absolute minimum NEED part, and the preferred WANT part. Then make all investment decisions with both goals in mind — guarantee the NEED at all costs, and try to increase the odds of meeting the WANT part through increased savings, or by choosing riskier investments. But the NEED part should be in risk-free guaranteed investments.

  5. Nickel

    Guys… The “long timeframe” argument (above) started because LOL linked a chart showing inflation adjusted returns. While I agree that the stock market can underperform across potentially significant time periods, esp. when adjusted for inflation, you conveniently dropped the inflation adjustment when you turned your attention to CDs. While you could “guarantee” a decent income, you’re assuming that the person in question has enough disposable/excess income to save the buttload of money that will be required to keep up with the ravages of inflation.

    Kevin: The stock market, on average, increases. Thus, your statement that you’re “almost guaranteed” to face a big loss over the short term is incorrect. While I understand (and agree with) your point about using the stock market to play catch up late in life, you’re overstating things here.

  6. Anonymous

    LOL–I have to respectfully dissagree with your last paragraph. If a person hasn’t saved enough, or started late in the game, stocks won’t be the answer. I say this because the stock market never “cooperates” when we NEED to make big money fast.

    If you’re 59 years old and plowing money into the market in hopes of making a big hit so you can retire it’s almost guaranteed you’ll get a big loss instead. In that situation you’d be far better with a CD strategy, plus plan on working for the rest of your life.

    The stock market is completely variable, and not the place to take chances on short term bets.

  7. Anonymous

    Neal: You ask for an alternative? My answer would be that you could _guarantee_ a decent retirement by having a realistic retirement goal, and saving enough to meet it (in no risk CDs that match inflation). Of course the younger a person is, the easier it is to pull this off.

    This ‘advice’ is counter to what any financial professional will tell you, but it is a realistic alternative. Why invest in the stock market (and take those risks) when you don’t need to?

    The only time anyone should even consider stock investments is if they are not saving enough (savings rate), or they started saving late (not many years left till retirement).

  8. Anonymous

    Kevin – I also agree w/you. We do seem to be in uncharted waters.

    I personally believe in investing with trends but I find that frustrating too. Not because I expect perfection – I don’t. But sometimes, clients expect a system, based on trends to ALWAYS beat the market and work miracles which it does not do. Trend investing, IMO, is a long-term strategy too. That means anyone using it would have to accept underperformance at times.

    Nice response sir.

  9. Anonymous

    Neal–Completely agree, there is no viable alternative to stock market investing! But keeping that in mind, it helps to stack the deck in your favor by any means possible. Since nothing stock related can be known with any real certainty, it’s a matter of playing the market based on it’s trends, and always within the framework of a comprehensive strategy that includes unrelated, and hopefully, mutually exclusive investments as well.

    My own guess is that the market will be far less predictable in the next few years than it’s been for most of the time since 1982. We seem to be in the early stages of a major league transition.

  10. Anonymous

    Seeking Alpha, Kevin, I agree.

    Unfortunately, there are such periods. You may not agree with me, but I liken it to wearing seat belts. You could possible die because you wear them but chances are they will save your life. You could have a long-term time frame, invest in stocks and still fail…but what is the alternative?

  11. Anonymous

    Seeking Alpha–Very good point. When the Dow crashed in 1929, it didn’t return to it’s precrash high until 1954, 25 years later. And that was without inflation figured into the mix. If it were it might have pushed the breakeven into the 1960s.

    Some great money must have been made by anyone buying after the crash. So the moral of the story is that it’s better to buy after a major sell off.

  12. Anonymous

    “Nobody can guarantee how an investment is going to work out — not even Jim.”

    Not even Jim? How about especially not Jim? His picks may be fun and his explanations/reasoning educational, however, he has a dreadful track record ever since the introduction of Mad Money.

    In the past two years, he has made many more poor (even catastrophic) recommendations than good. Listen to him if you enjoy it; I personally think he has a good personality and is entertaining, but do yourself a favor and don’t buy based on Cramer.

  13. Anonymous

    Nice post! The market timing issue is a big one. Too many people think they can do it and in fact even the pros struggle with it! Most of the investing public would be better served by a disciplined dollar cost averaging approach.

  14. Anonymous

    Hey Retireby35 – right on. It’s like going to the track and winning first time out. That’s the worst thing that could possibly happen to you.

  15. Anonymous

    Very good advice and information.

    One thing I’ve seen time and time again is novice investors have some beginner’s luck in the stock market and then they bet bigger and bigger amounts on riskier and riskier stocks. But the thing they don’t realize is that one big misjudged bet will wipe them out.

  16. Anonymous

    Kevin,

    I completely agree with you again. Individuals CAN do it but it takes a great deal of discipline. The emotions take over and the logic shuts down. That’s why most folks don’t make money. IMHO

  17. Anonymous

    Plus, when you’ve got money riding on an investment, there’s a tendency to move toward action, even when patience is the order of the day. If only it were a pure money thing, but there’s so much emotion involved.

  18. Anonymous

    Sean, I agree with you. Cramer is entertainment. The problem is that most people don’t understand that.

    Kevin, I think you are right. These 4 mistakes basically point to the problem that you identify as the “big picture” and these 4 kind of break that down. At least, that’s been my experience as a financial adviser.

    Leslink, I agree that trading makes no sense for most people. Unfortunately, some folks start out as investors and become traders for the reasons I’ve outlined. They don’t see themselves as traders but traders they are.

  19. Anonymous

    Telling yourself to invest in the stock market “to make money” is to wide of a goal. At some point, I realized that there were two main strategies: trade or invest. Trading requires more attention on a day to day basis and close attention to the predictions. Investing is all about years of time and asset allocation. But both require time and energy and alot of patience. So, first, make a choice with which method and then make sure you’re not tempted to jump to the other side (e.g., start trading or investments — “I see a deal I just need to move this into a trade!”, or turn your trades into long term investments — “I’ll just let it ride even though I’m 30% down”)

    Personally, I dislike mutual funds because it removes all the control and I ended up doing just as much research as fund managers trying to find a fund with the right mix, but I realize that not everyone has the time to do the day to day watching or even picking of stocks.

    ETFs are bit better, but they still suffer macro effects, especially if its a sector ETFs. Plus, some ETFs are doing some new tricks which just confuses it more (3X bull/bear). Tread carefully.

    In the end, its your money, and never forget it. Too many people see the stock market as a casino (e.g., “Put all of it on stock XYZ! Come on big money!”).

  20. Anonymous

    Neal, I think you’re providing sound advice, but I also believe that a “bigger picture” issue is that the average Dick and Jane don’t have the patience, instincts, time or information base to successfully invest in the stock market. Ordinary people can and do lose money even in bull markets. Just the fact that a person might get their investment advice from a guy on TV is troubling.

    It takes more talent than the financial media ever admit, and of course the long cycle bull run of the 1980s and 1990s made a lot of ordinary folks come to believe they were investment geniuses after year after year of double digit gains. Worse, many were believing the market to be a benign venue! Since 2000 it’s been a very different story and millions have been burned.

    For the average person, it’s best to recognize and respect that the stock market IS volatile, it MIGHT not cooperate with your long term plans, is NO place for non-professionals, and even professionals get burned in down markets.

    I’m not a financial planner or investment genius, but from what I’ve seen, the best route for a non expert is to invest through mutual funds, buy only after a steep and sustained sell off (risk reduction), allocate only a minority percentage of your money, and be prepared to sit back and wait, many years if necessary.

    Even then, as you said, there are no guarantees!

  21. Anonymous

    Your opening statement”Imagine you just heard Jim Cramer talking on CNBC about a guaranteed way to make a fortune with your Investments”would never happen.Jim Cramer is all about education and entertainment.I learn something while laughing every night.

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