How to avoid bad investments?
In a recent post, we tackled the essential question: “How should I invest?” If there are ways that we recommend you DO invest, it seems only fitting to cover the related subject: ways we recommend you do NOT invest.
But actually, “How can I avoid bad investments?” is a trick question. The trick is not to try to avoid the bad eggs by dumping particular securities, sectors or markets based solely on recent or expected underperformance. When you try to avoid bad-news bears by picking stocks or timing the market in this manner, there are several reasons why you cannot expect to improve your outcomes:
- None of us can consistently predict future market performance. It’s not just news, but unexpected news that alters future security prices. By definition, the unexpected is impossible to predict, as is how dramatically (or not) the market will respond to it.
- The market is faster than you are. In today’s electronic environment, price adjustments typically occur within the first few post-announcement trades. That means, by the time you hear bad news, the market already has set new prices in response, and it’s already too late for you to avoid the damage done (plus, again, nobody knows what’s coming next).
- Your investment babies are in the bathwater too. In seeking to avoid bad investments, you’re just as likely to miss out on the next great performers too, and incur unnecessary trading costs while you’re at it. The effort is thus expected to cause more harm than good to your end returns.
The next time you’re tempted to avoid or dump bad or scary investments, our advice remains to step away from the costly trading button and stick with your carefully designed, custom-crafted Investment Policy Statement (IPS) to guide your investment decisions. To quote the prescient Canadian physician William Osler (1849–1909), “When schemes are laid in advance, it is surprising how often the circumstances fit in with them.”
What’s that? You don’t yet have an IPS? Give us a call and we’ll be happy to help you get started.