Every investment has the potential to offer you something – better returns, diversification, less volatility, more security – but most investors overlook the baggage that tags along.
I’m not talking about the stuff you carry on a plane. These are pre-existing problems you don’t find out about until much later in the relationship.
Simply, there’s always a tradeoff that must be weighed with every investment decision.
Most investors focus on the potentially good outcome while overlooking the bad possibilities and problems. The pros are why you invest. The cons, warts and all, that cause mistakes and bad behavior are often overlooked or ignored.
Nobody likes to think through the downsides. But that’s exactly what needs to be done. You need to manage both the good and bad qualities of every investment. Understanding the baggage each investment brings is the best way to not be shocked into doing something you shouldn’t when the unexpected happens.
And if you think the investment is baggage free, then you’re blinded by some bias and you need to look harder. There’s always a potential downside, however small. Every investment has a tradeoff. You need to find and accept it before you get involved.
Here’s a few examples:
Stocks – You see the potential for higher returns over the long term.
Baggage – Randomly high volatility offers no short-term certainty and makes you queasy from the swings of gains and losses.
Bonds – You see the safety, security, and consistent yield from bonds.
Baggage – The constant battle for yield to outrun inflation could fail, leaving you to still earn money from the bonds but the money earned buys less after inflation.
Asset Allocation – You see the protection diversification offers from never having the worst returns in any given year, but also decent average returns over time.
Baggage – The annual temptation to chase another investment that beat your returns grows because you will never have the best returns in any year.
High Yield Bonds – You see a higher yield that pays you more than government bonds.
Baggage – The bonds could leave you with no yield and little to no principal because of higher default risk, if the big price swings don’t scare you away first.
Stock Picking – You see the chance to beat the market by a lot.
Baggage – A similar chance to lose to the market or just lose a lot.
Value Investing – You see a strategy that offers the opportunity to outperform the market average over the long term.
Baggage – The time it takes stock prices to reach fair value takes longer than your willingness to patiently wait.
Income Investing – You see the opportunity to own assets that pay a consistent stream of money.
Baggage – The stream grows slower than you expect or need and more income now could mean less capital gains to draw from in the future.
Dividend Stocks – You see a high dividend that pays a lot today or a low dividend that should pay you more over time.
Baggage – Everyone sees it, wants to own it, overpays for it, and sells when prices fall, scaring you to sell when you shouldn’t. Or the dividend gets cut or canceled, leaving you to reach for yield later on.
REITs – You see how great REITs performed over the past fifteen years.
Baggage – Interest rate moves impact prices more than you expect. Then the tax bill comes showing REIT yields are taxed as income, not qualified dividends.
ETFs – You see an easy way to buy a variety of the lowest cost index funds available.
Baggage – The ability to quickly and easily sell any fund when you shouldn’t.
Active Funds – You see a fund manager who’s beaten the market in the past few years.
Baggage – Everyone else does too, floods the fund manager with more money than he can effectively invest, and now you have a high-cost active fund underperforming a low-cost index fund.
Short Selling – You see an overpriced stock that has to fall in price any day now.
Baggage – The unpredictability and emotion of the market in the short term can turn your short sale into a short squeeze and an infinitely big loss.
Cash – You see the optionality cash offers – the opportunity to buy investments that fall in price or to rely on in a pinch.
Baggage – You could wait a long time earning very little interest, that doesn’t beat inflation while dealing with the constant fear of missing out.
Calling the Top – You see the chance to get out before the next market crash.
Baggage – You end up being wrong much more often than you’re ever right and your returns suffer while you wait for a crash that rarely comes.