Preventing “The Big Mistake”

by | Dec 9, 2005 | Cash Flow, Weekly Column

What is the greatest value that financial planners provide for their clients? There are many answers to this question, depending on the needs of the client and the style of the planner. One of my favorite answers, though, is that I can keep clients from making “The Big Mistake.”

Is it possible for someone untrained in financial management to be a successful investor? Of course. Doing so requires the patience to think long-term. It requires the willingness to go for the boring rather than the spectacular by buying mutual funds rather than individual stocks. It requires learning the fundamental principles of investing—diversification and asset allocation.

Someone who is unable or unwilling to follow that approach is extremely vulnerable to making “The Big Mistake.” One of the most common mistakes for untrained investors is buying individual stocks. Another is concentrating your investments in one asset class, such as stocks. Both these approaches can cost you dearly if that company suffers losses or that sector of the market declines.

What happens all too often is that one “Big Mistake” leads to another. I’ve seen investors who had huge losses as a result of not being diversified. They promptly turned around and put everything they had left into a different asset class in an attempt to recoup the loss. This is just taking all one’s eggs out of a failed basket (such as stocks) and putting them into a different one (such as bonds). It’s only a matter of time until the market changes, and the result will be another loss.

If your portfolio has suffered a loss because of a lack of diversification, don’t compound your problems by jumping from the frying pan into the fire. It is important that you accept the fact that what is lost is lost and that you don’t make things worse by continuing to act irrationally.

There is actually a grieving process that a person needs to go through with any loss, even a financial one. You need to go ahead and be angry, sad, scared, and feel whatever emotions this loss creates. However, that is not the state in which you should make new financial decisions. Once you’ve gone through the grieving process, you can begin to separate the feelings about the loss from the rational actions you need to take to protect and build your investments. This separation will help keep you from repeating past mistakes.

There are two reasons why using the services of a financial planner can keep you from making those “Big Mistakes” in the first place. The planner’s training and financial expertise, of course, is the first reason. (This, of course, is assuming the planner is competent and understands asset class diversification. At its simplest, this means building portfolios that include a minimum of four asset classes.)

A second aspect of the value you receive from a financial planner is the professional detachment a planner brings to managing your portfolio. The planner can make decisions in cold blood, looking at such factors as whether a mutual fund manager’s performance is declining or a particular asset class is thriving. He or she isn’t hampered by emotional factors such as guilt over selling the stocks your late husband bought or your Aunt Eloise recommended. Quite simply, it’s often easier to invest wisely with someone else’s money.

Can you learn to manage your own investments? Yes, if you choose to. Should you? Not necessarily. You can invest the time and energy to educate yourself thoroughly, or you can invest in a professional advisor. You’ll need to do one or the other if you want to avoid “The Big Mistake.”

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