A new client recently came into my bank branch with a check for $10,000... he was ready to invest.
He sat down in my office and told me that he wanted to buy gold. We don't sell gold directly in our bank branch; however, we do offer a precious metals mutual fund that invests in several companies who mine gold.
This client didn't want to hear anything about investing in a well-balanced mutual fund that has a focus on the gold, mining and precious metals sector. All he wanted to do was buy gold directly -- and that's exactly what he did through a self-directed brokerage account.
I asked him why he wanted to buy gold... He said that his friend told him gold was a good investment because he saw on the news that the price of gold is going to go up. The client saw buying gold as an opportunity to make a quick buck, and who doesn't want to do that?
Two weeks later, the same client was back in my office because his $10,000 investment dropped to roughly $8,000 and he was not happy. Bottom line? My client screwed up on so many levels, and he didn't know how to make things better. That's where I came in. But first, let's look at how he screwed up:
Buying On A Friend's Tip:
Classic mistake. Your buddy has a hot tip that you just can't pass up. But here's the deal: By the time you hear it, it's probably not so hot anymore.
So, this is my advice -- listen to your financial advisor. He has a degree in finance and your friend probably doesn't. Financial advisors are trained to give well-balanced financial advice; they focus on long-term investing strategies instead of just trying to help clients make a quick buck -- which can actually end up in big losses.
Ignoring His Risk Tolerance:
After my client answered a series of questions about his time horizon and comfort level with risk, we determined that he was actually a balanced investor, not a high-risk investor who should be putting his entire life savings into one investment in a single sector.
Lesson learned: Don't go against your natural investing instincts. If your investor profile says that you are a balanced investor, don't try to take more risk than you are comfortable with. Very often, people who purchase higher risk investments lose faith in the market when they experience fluctuations, and they end up going to the other extreme and keeping their money in low interest savings accounts -- this is not helping anyone's money grow over the long term.
And long-term growth should be your goal. That's what Warren Buffett focuses on. He famously said that his favorite timeline for holding a stock is 'forever.' So how do you identify a 'forever' stock? These companies typically have some huge and lasting advantage over the competition, hold lots of cash, pay a fat dividend and buy back massive amounts of stock, boosting the value for the rest of the shares. (My colleague Elliott Gue just released his report, 'The 10 Best Stocks To Hold Forever.' Click through to get your copy of this report.)
Putting Too Much Money Into One Basket:
High-risk investments are all well and good, but they need to be built into a balanced portfolio, which my client later learned.
High risk investments offer the possibility to make big returns over the long term, but they also offer the possibility of losing your savings. High risk means large fluctuations and you have to be willing to stay invested during the down times in order to make a profit over the long term. It is very rare that high risk investments such as investing in one isolated sector or one stock will help you make money over night.
The smarter investment solution is to add a small percentage (5% to 15% of your overall portfolio depending on your comfort level with risk) of high risk investments into a well balanced portfolio. This gives you exposure to the investments you want without putting all your money on the line. If the market drops, only a small part of your entire portfolio will be affected.
Meanwhile, what can we learn from my client's financial mistakes?
If you make an investment mistake, you will most likely be able to make your money back, but it won't happen overnight. My advice to the client was slow and steady wins the investment race. If you are recovering from an investment loss, invest your money in low to medium risk mutual funds or ETFs that offer a steady stream of interest or dividend income with the potential of capital gains over the long term. This will help recover your losses slowly but surely.
We rebalanced my client's portfolio to include lower risk investments such as domestic fixed income and equities; we also kept a little bit of money invested in gold -- just to make him happy. That's the compromise that financial advisors and clients have to make; they need to find the perfect balance between what the client thinks they want and the best investment option based on their time horizon and risk tolerance.
The Investing Answer: How many of us bought gold because we heard it was a good investment? The truth is if you are hearing about an investment tip on the news, it's most likely after the boom, and it's probably too late to make the 'big money.' Investors don't get rich overnight; the key to making money is not trying to time the market, it's investing in a well-balanced portfolio that grows steadily over time.
