My one, cardinal rule for investing

coaching investing Feb 01, 2021

I am not an investment advisor. 

Let's just get that out of the way at the outset, because I don't want anyone to think I can (or will) tell them which investment vehicles to use to make their money grow.

I can, however, tell you where NOT to put your money.

Almost any investment can be good, given the right circumstances.

But here's the one investment that's NEVER wise:

The investment you don't fully understand.

This is my one, cardinal rule when it comes to putting money aside for the future: never get into an investment if you don't 100% understand how it works. 

I got to thinking about this over the past week, with all the excitement around  GameStop and the hedge funds being hoisted by their own petard. If you're not familiar with the story, check out this excellent article that explains what happened in layman's terms.

A lot of people who know little to nothing about shorting stock, or stock market investing in general, have jumped on the bandwagon that's driving GameStop's stock way beyond its actual value. They are likely caught up in the excitement and fever of "besting" the hedge funds, seeing it as a triumph of the "little guy" over "big, bad Wall Street". 

It's a fun story. But is it wise? 

I don't have a crystal ball to tell you what's going to happen and how this is all going to end. But the experts all seem to agree that the stock can't stay high forever. Without getting too technical, the basic premise on which the stock market is based, is that a stock's value represents the total value of the company, divided by the number of common shareholders.

If the stock price is higher than the actual value of the company, sooner or later it must fall, as it's artificially inflated. When that happens, those who have participated in this wacky game could lose their shirts, if they got in too late (i.e. paid a high price for their shares as it was climbing) and/or if they don't get out soon enough (i.e. they hold on too long and the price drops below what they paid). 

Even expert fund managers and investment brokers lose money sometimes, on individual stocks.

Does that mean stock market investing is a bad idea? Not necessarily. If you know what you're doing, there are ways to mitigate the risk, such as "diversifying your portfolio", which is just a fancy way of saying, buying several different stocks with different risk profiles, so that if you lose money on one, you hopefully will gain on another to more than offset the loss.

But most of us don't have that level of expertise; that's why we rely on the experts, such as mutual fund managers and investment brokers. Not only is it harder for us to assess the true value of a stock and to predict whether or not it will go up in value over time, but there are also different types of stock (some pay dividends, others do not, for example), as well as tax implications to consider.

And stocks are still a pretty basic aspect of investing that most people are familiar with. Over the past 20 years or so, many increasingly complex "financial instruments" have been invented that even I, as a CPA, don't understand in very much detail. You may have heard some of the following terms:

  • Futures
  • Forwards
  • Options
  • Swaps

These so-called "derivatives" are contracts between two parties, and the value of the contract is derived from one or more underlying assets (such as a stock or a bond). 

And now we also have "Cryptocurrencies" like Bitcoin, Ethereum, and Cardano.

There's a LOT of money made every day by the exchange of these derivative contracts and cryptocurrencies, but if you don't understand thoroughly how they work, it's really easy to lose your shirt. I personally would never put my money in any of these, because I don't have the expertise to understand what my level of risk would be in a particular scenario.

If you want to be a financially confident woman, one of the keys is to know and understand where you are putting your money, and what it's doing for you. Trust me on this - you don't have to jump in on the latest trend in order to grow your money, and you won't be "left behind" if you stick with investment vehicles that you already understand or can easily learn about.

Keep this cardinal rule top of mind, and you will have fewer sleepless nights worrying about whether your nest egg is safe.

 

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