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?