The past year was phenomenal for stock market investors. The S&P 500 index rallied nearly 30 percent, while technology stocks soared even higher. If you participated in the rally, you have reason to celebrate. However, it’s important to remember what it says in the fine print of every prospectus: past performance is no guarantee of future performance. Your future success will depend on how well you make investment decisions in 2022 and beyond. Here are 5 principles that can help guide you as you make those decisions.
1. Remember the difference between investing and speculating. The distinction between the two often gets blurred in the popular press and in every day conversation, but understanding the difference is vital. I once heard someone say that investors are like farmers and speculators are like miners. A farmer plants a crop, nurtures it to maturity and then enjoys the harvest. A miner, on the other hand, digs a hole and hopes to quickly strike it rich. As an investor, you are playing the long game. Keep your focus and don’t get caught up in short-term speculations.
2. Keep your eye on what is real. With the exception of Hollywood and Las Vegas, I don’t know of any industry that makes more money hawking illusion and dreams than Wall Street. The financial wizards are always coming up with something shiny and new to beguile the gullible. Remember, if something sounds too good to be true, it probably is. If an investment offers you an outsized return, it probably carries outsized risk—even when the risk isn’t apparent. Especially when you are dealing with Wall Street, you never get something for nothing.
3. There is such a thing as being “too conservative.” Sometimes we unknowingly increase our risk as we try to play it safe. For example, most people react poorly to market volatility and several academic studies have documented the increased levels of depression and anxiety that accompany major market downturns. This is in spite of the fact that long-term investors holding well-diversified portfolios of high-quality stocks have rarely been harmed by market volatility. On the other hand, very few people lose sleep over inflation, yet inflation is a much more potent long-term risk. In fact, over the past thirty years, if you had “played it safe” by keeping your savings in cash, inflation would have cut the value of your savings nearly in half. If instead your investments had earned the total return of the S&P 500 index over the same thirty-year time period, the value of your savings would have grown by more than 13 times after accounting for inflation.
4. Emotions make bad decisions. I know this is easier to say than to do, but you have to keep your emotions out of your investment decision-making process. The two emotions that get investors into the most trouble are fear and greed. Emotional investors bail out of good investments when the market drops because they allow fear to overwhelm their reason. Their catastrophic thinking impels them to sell and, too often, they sell just in time to see the market turn around.
Greedy investors have the opposite problem. They jump into an investment (in this case, it is really a speculation) because the market is rallying and they are afraid they will be left behind. They suffer from FOMO (fear of missing out) and often jump in just in time for the market to roll over. So, remember—FOMO is for chumps. Before making any investment, check your emotions, do your research, and understand why you are making it.
5. Smart is better than lucky. Early in my career, I worked as a bond trader for a large primary dealer in Los Angeles. One day, a much more experienced trader asked me, “What do you think—is it better to be lucky or smart?” As I’ve pondered that question over the years, I have come to the conclusion that it is much better to be smart, at least when it comes to investing. Lucky investors seem to eventually come up short. Smart investors tend to make their own luck by following sound principles over time.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to smerrell@montereypw.com.