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There are many investors who are “once
bitten, twice shy” when it comes to investing, especially those that
have had significant losses in the past. Unfortunately, those bad
memories are causing many of them to make bad investment decisions
today. Over-generalizing past experiences, both good and bad can
have dire affects on your hard-earned nest egg.
Many people who traditionally shunned stocks began investing in the
stock market during the ‘90s. They were handsomely rewarded. But
those investors (and their advisors) failed to realize the dramatic
shift that began occurring in 2000. As a result, many lost much of
what they had gained, some selling out with huge losses.
It’s understandable that someone is hesitant to invest in an area
where they’ve lost significant amounts in the past. One of the
biggest mistakes investors make, though, is to overreact to
investment experiences. You certainly want to learn from the past,
but a knee-jerk reaction will create a host of new ones that will
greatly impact you long-term.
Stock markets naturally fluctuate, but these ‘bitten’ investors
become very nervous with even minor market drops. The truth is that
the markets don’t move up in a straight line. You can’t take your
money out of the market every time it posts a small loss and
reinvest later after it’s recovered—you’ll continue to lose money.
Past experiences cause many investors to entirely shun a category
that should play an important role in their portfolio. Many
investors today want to avoid equities all together. Others might
avoid real estate. You may have lost money in a bond mutual fund and
now avoid all mutual funds. But avoiding any category completely is
a big mistake. A properly balanced portfolio has been shown to
contain less risk than an unbalanced one.
Some REITs provide an excellent, stable source of income but some
investors avoid them like the plague because they bear a slight
resemblance to failed limited partnerships of the 80’s. They’ve
allowed losses they suffered on LPs years or decades ago keep them
from benefiting from quality REITs today.
Just as bad experiences color our investment vision so do good
experiences. This can cause investors to over-invest in a single
category. Technology stocks are one example, bonds are another. For
the last two decades, bonds have given returns approaching the high
single digits, making them the investment of choice for retirees.
Bond’s great returns have caused many retirees to over-invest in
them. Most have seen the level of interest they receive plummet the
last few years and have turned to risky investments to replace that
lost income. This puts them in a precarious position moving forward.
Successful investors have learned the secret of not overreacting and
over-generalizing. They recognize that their bad experiences could
have been the result of issues specific to an investment but didn’t
affect the rest of the category. Perhaps the mutual fund they were
in had bad management or used an ill-timed strategy. But that
doesn’t make all mutual funds bad.
They also realize that various investments will perform differently
depending on the market and economic environment. The same
investment can be the worst possible investment in some situations,
but the investment of a lifetime in other situations.
For instance, there is a mutual fund called Rydex Tempest that is
designed to produce a return twice the opposite performance of the
S&P 500. Funds like this are called ‘inverse funds’ because they
move up when the index goes down and down when the index goes up.
In 2003, Rydex Tempest dropped 43%! An investment of $100,000 in the
beginning of that year would have been worth only $57,000. On the
other hand, Tempest was up 37% in 2002—a terrible year for the
market.
Is this fund a good or bad investment? Neither. There’s just a right
time and a wrong time to be invested in it. When it comes to
investments like stocks, bonds, mutual funds, or real estate
investment trusts, how and when the investment is used will in large
part determine whether it was a good or bad investment.
So don’t let the ghosts of markets past cloud your investment
decisions today. Don’t overreact. Properly managed, each category of
investments will play an important role in your portfolio.
I’ll personally answer your financial questions. Go to
www.guardingyourwealth.com and click on ‘Ask Jeff’.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide. |
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