Key Points
– Market timing, involving shifting large portions of investments based on short-term market forecasts, often leads to poor outcomes.
– Concentrating investments in a single security, such as company stock, significantly increases risk due to higher price volatility.
– Private investments, while potentially lucrative, carry heightened risks due to lack of transparency and liquidity, increasing susceptibility to fraud.
I ended my Q&A last month with “I’ve been managing client assets for 34 years and the only people I have ever heard of that had catastrophic experiences did so because they exposed their personal financial standing to worst case scenarios that were far worse than what a diversified portfolio has ever produced,” and promised to outline some of those mistakes this month.
So, what are those worst-case scenarios?
There are a bunch. For today, I will highlight just three investment-related ones that are of similar ilk. Namely, they involve committing too much of one’s assets to what is thought to be a sure thing.
The first is market-timing, trying to move large portions of one’s holdings in or out of the market based on a forecast of how the market will behave in the near term. This maneuver is often fear driven fueled by the political media. As a core strategy, the approach has a terrible track record.
Sure, you may get it right but doing so just increases the chances you’ll try it again but with more money. It is the same psychology that makes casinos profitable. Unfortunately, when you are wrong, the effects can be very damaging.
The second is too much money in one security. Subjecting too much of your assets to the behavior of one security is very risky. We see this often with employees owning too much of their employer’s stock or people who inherit large amounts of a particular stock. We hear statements rationalizing the large holding like “We’ve made good money with the stock and with our new (fill in product or service here), its going be great,” or “It’s been good to the family and dad said to never sell it.” One problem is that on average, the price volatility of individual stocks on average is double that of the market.
The price of an individual stock is not only subject to risks of the marketplace in general but is also subject to risks unique to that company, Putting all their eggs in one basket is one way people get rich but most who concentrate their holdings do not fare well as only a few stocks produce extraordinary results.
Even worse than the odds of a superior outcome from a concentrated position is the effect when something goes wrong. At the extreme, the stock of an individual company can become worthless. A properly diversified portfolio cannot. If you have too much in one company and that stock tanks, it can permanently damage your financial security.
The third catastrophic scenario applies to private investments. Tying up too much money in a security with no public market adds yet another additional layer of risk. As any entrepreneur will tell you, this in and of itself is not necessarily a bad thing. It turns bad when the buyer of a private investment downplays the added risks and commits too much of their assets. It is the aforementioned concentration problem with the added wrinkle that liquidity is typically low and doing proper due diligence is often a challenge.
The lack of transparency is what makes fraud much more prevalent with these private “deals.” Most private investments are not fraudulent but almost every fraudulent disaster you’ll read about will involve some level of private investment.
When the goal is true financial security, being a diversified, patient and disciplined investor is a much more reliable approach to the markets than speculating on market movements or the fortunes of individual holdings. A key to staying diversified, patient and disciplined dynamic is planning and planning starts with purpose. Who and what is this money for and when is the money needed? Have a good plan. Investing your life savings is wise. Betting your life savings out of fear or greed is taking on risk that could draw a terrible result, a result that is entirely avoidable.
Dan Moisand, CFP® has been featured as one of America’s top independent fee-only financial planners by at least 10 financial planning publications and practices at one of America’s most decorated independent firms. For more info, e-mail him at dan@moisandfitzgerald.com, visit moisandfitzgerald.com or call Dan at 321-253-5400, Ext. 101
Originally published on FloridaToday. Read the original article here.