Be careful about making assumptions
It's only human to make assumptions. Think about it: Could you get through the day without making a few assumptions? Probably not.
The end of the year is a good time to challenge your assumptions, especially those regarding investing. Investors thinking about making, or not making, certain moves make assumptions aplenty, causing them to:
• Throw good money after bad. If your investments haven't been delivering results, don't double down on them, clinging stubbornly to the assumption that you were right to make them in the first place. As Kenny Rogers said, you have to know when to fold 'em.
• Neglect their portfolios. Good investment returns are a wonderful thing, but they can throw your portfolio out of balance, playing havoc with your asset allocation. For example, stellar performance from large-company stocks for an extended period can increase your risk from this category by overly extending your allocation to this asset class, so don't assume that it's a good idea to let your portfolio sit unattended. Rebalance when necessary by selling some of the winners in one category to invest in others that may be temporarily down, thus realigning your portfolio's weightings in different types of investments in accordance with your original asset allocation.
• Hide from risk. Sure, risk can be scary, but don't assume that hiding from it is a good idea. Like many investors, you may have taken a big hit in the market meltdown of 2008-09. But those who panicked and cashed out then probably wish they hadn't because of the surging market run-up that followed in 2009–10. Had they just remained invested, many of their losses might not have occurred. Remember: You have to be in it to win it — to get the large gains that tend to occur on precious few days. Because it's impossible to know which days these will be, you need to remain invested. (This is a different subject than how you invest, which is extremely important). Don't rationalize sitting on the sidelines because of fear or uncertainty. If you aren't in the market, you will almost certainly lose opportunities.
• Wait for the clouds to part. If you assume that they will, you could grow old waiting. To invest new money, many need emotional certainty — something that just doesn't exist in the market. The future is uncertain.
The big cloud mass whose disappearance many investors are currently awaiting is market volatility — wide swings in stock prices. But it can take a long time for volatility to ease and, in the meantime, you may miss significant investment returns. Volatility tends to punish stocks selectively, but a well-constructed, beautifully diversified portfolio holding many different asset classes can withstand the roller-coaster ride. Or you could just put your money in your mattress and get eaten up by inflation, which may significantly increase in the coming months or years. Don't allow the powerful emotions of fear and greed, the worst enemies of successful investing, become your guide to how and when you invest.
• Chase yesterday's performance. All prospectuses state in bold print that past performance is not an indicator of future performance because it's true. Far too many investors see a recent, good year for an investment and assume that the following year will be similar. However, they are usually wrong. Long-term future performance often tends not to reflect recent past performance but rather decades of past performance. (This is known as regression to the mean.) But unfortunately, chasing recent past performance is the most common mistake of investors.
• Take investment tips from friends. If you go to a party and hear about a great investment, chances are that it's already priced up, limiting your potential gain. Buying on popularity is a fool's errand. Your friends may have luckily gotten in at lower prices, but when you assume you'll get the same returns, you'll likely be helping them, not yourself. By pursuing what has worked for others, you've forgotten that you cannot purchase past performance.
As with anything else in life, if you regularly and wisely evaluate and challenge your assumptions, you'll help ensure that you're investing based upon wisdom — not false, dangerous assumptions. And now that I've personally challenged you, remember: Knowledge does equal responsibility.
Tim Decker, a fee-only financial planner, is president of ISI Financial Group in Lancaster. He is the author of "The Sleep-Well-At-Night Investor" and host of the radio program "Financial Freedom," which airs at noon Saturdays on WHP-AM 580. Contact him at www.isifinancialgroup.com.
This content is based upon information believed to be accurate by ISI Financial Group, Inc. However, it should not be relied upon for legal or accounting purposes. Past performance is not indicative of future performance. Investments involve risk, including the possible loss of principal. Always seek professional advice before making any financial or legal decisions.