With the stock market crash of 2008-2009 fading out of view in the rearview mirror, many new investors may be wondering how safe the investment game truly is in the slowly recovering American economy.
In these calmer financial times, it’s especially important to weigh and to carefully assess the risks of a potential illiquid investment before committing. This is because embedded risks often rise as visible danger subsides. It is during these times that some investors unwittingly take too much risk, only to realize that risks after purchase; when the next financial storm hits.
RISK OF LOSS OF PRINCIPAL SHOULD ALWAYS BE CAREFULLY CONSIDERED WHEN LOOKING FOR RETURNS
Before committing to an investment or handing any money over to a financial advisor or firm, keep the following in mind:
Carefully vet financial advisors. Take the time to thoroughly investigate any potential business partners. Make sure they’re properly licensed and registered, have legitimate financial designations or education, and are free or regulatory, investor, or financial problems. Choosing a financial adviser who is trustworthy, professional, and skilled is often more important than attempting to vet everything you buy from the professional (due to the complexity of the financial markets and financial products).
Get everything in writing. And, as a corollary, don’t rely on representations from your advisor that are different or inconsistent with the written representations. Your financial adviser should be able and willing to provide a hard copy of any representations made regarding the proposed investment. If they don’t act consistent with their written representations, end the relationship.
Once you have carefully selected your financial advisor, remain vigilant, and keep in mind that most investment professionals use the following general investment touchstones:
ASSET ALLOCATION AND DIVERSIFICATION WITHIN ASSET CLASSES
A concentrated portfolio is usually a risky one. You typically don’t want to invest everything into one industry or one market. When considering this, consider what assets or job you may have outside of your securities portfolio. For example, if you make a living in the real estate business and also own real estate that you rent out for income, then don’t let a financial advisor recommend you have “exposure” to real estate investments such as REITs when you are already heavily exposed to real estate risks outside of your investment portfolio. Many financial advisors fail to consider your total financial picture when recommending a securities portfolio. If you are overconcentrated in a market that takes a downturn, or another overtakes it, you might suddenly find yourself at a significant loss and, depending on the nature of the investment, you may not be able to sell the investment and limit your losses. The concepts of asset allocation and diversification are essentially a fancy way of saying “don’t put all your eggs in one basket.”
ACCEPT LOSSES AND MOVE ON RATHER THAN HOLDING THE LOSERS
There are many fancy-sounding measures to protect you from a declining stock position. For example, you can set “hard stops” on your stocks in which you set a price at which your stock will automatically sell. You can also set up what are known as “trailing stops,” which aim to protect your gains and simultaneously guard against losses. However, more important than these specific techniques is a mindset that involves discipline to accept an investment mistake and make a good business decision as to whether to hold or sell an existing investment. Failure to have this discipline can result in much larger losses and missed opportunities on how the investment funds can be redeployed.