Assumptions can be dangerous to investors
December 19, 2013
Every day of our lives, we make assumptions. We assume that the people we encounter regularly will behave in the manner to which we are accustomed. We assume that if we take care of our cars, they will get us to where we want to go. In fact, we need to make assumptions to bring order to our world. But in some parts of our life — such as investing — assumptions can prove dangerous.
Of course, not all investment-related assumptions are bad. But here are a few that, at the least, may prove to be counter-productive:
"Real estate will always increase in value." Up until the 2008 financial crisis, which was caused, at least partially, by the "housing bubble," most people would probably have said that real estate is always a good investment. But since then, we're all more painfully aware that housing prices can rise and fall. That isn't to say that real estate is always a bad investment — as a relatively small part of a diversified portfolio, it can be appropriate, depending on your goals and risk tolerance. But don't expect endless gains, with no setbacks.
"Gold will always glitter." During periods of market volatility, investors often flee to gold, thereby driving its price up. But gold prices will fluctuate, sometimes greatly, and there are risks in all types of gold ownership, whether you're investing in actual bars of gold or gold "futures" or the stocks of gold-mining companies.
"I can avoid all risks by sticking with CDs." It's true that Certificates of Deposit (CDs) offer a degree of preservation of principal. But they're not risk-free; their rates of return may be so low that they don't even keep up with inflation, which means you could incur purchasing-power risk. Again, having CDs in your portfolio is not a bad thing, but you'll only want to own those amounts that are suitable for your objectives.
"The price of my investment has gone up — I must have made the right decision." This assumption could also be made in reverse — that is, you might think that, since the price of your investment has dropped, you must have made the wrong choice. This type of thinking causes investors to hold on to some investments too long, in the hopes of recapturing early gains, or selling promising investments too soon, just to "cut their losses." Don't judge investments based on short-term performance; instead, look at fundamentals and long-term potential.
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"If I need long-term care, Medicare will cover it." You may never need any type of long-term care, but if you do, be prepared for some big expenses. The national average per year for a private room in a nursing home is nearly $84,000, according to a recent survey by Genworth, a financial security company. This cost, repeated over a period of years, could prove catastrophic to your financial security during your retirement. And, contrary to many people's assumptions, Medicare may only pay a small percentage of long-term care costs. You can help yourself by consulting with a financial professional, who can provide you with strategies designed to help cope with long-term care costs.
You can't avoid all assumptions when you're investing. But by staying away from questionable ones, you may avoid being tripped up on the road toward your financial goals.
Doug Drost is a certified financial planner for Edward Jones, 2262 Reno Highway.