How to Make Smart Investment Decisions

When faced with almost limitless financial options, how do you make the right investment decisions? Clearly this is an important question and it was brought home to me only a few days ago.

A client I met with was sitting on a pile of cash she received from an inheritance. Kathleen was a successful small business owner and her husband Larry worked for the municipality. They both shared the same goal; they wanted to make work optional. In other words, they wanted to have enough passive income such that they wouldn’t be required to work if they didn’t want to.

When I met with Kathleen and Larry a second time I asked them to clarify their goals again. I assumed they hadn’t changed but I did this to create a “reference point” to go back to and see if indeed their financial behavior was in line with their financial goals.

Once I was clear that their goals hadn’t changed I suggested they consider real estate and a balanced equity portfolio as investments. I suggested these ideas because they were both long-term investments with potential for growth and income even though they also exposed investors to short-term risk.

The couple didn’t like these two options and instead gravitated towards short-term bonds. They acknowledged that the growth opportunities were attractive but they had a great deal of fear about the short-term prospects for either investment.

Of course I agreed. They made a good argument and nobody (not even me) could predict the future. They suggested that a better course of action would be to make ultra-short-term investments until the first of the year when things “would be clearer”.

While I understood the logic of their argument, I did not agree with their conclusion. In my opinion, relying on such a process was dangerous. I really didn’t think they were thinking about this from the best place possible. There were two reasons I felt this way:

1. What if they were right?

They might be right that the stock market would be dicey over the next several months and real estate would continue to decline. But once that initial 6 month period passed, they’d be in the same boat, full of anxiety about the future and they still wouldn’t know what tomorrow had in store. They’d probably continue to invest using short-term serial investments and get stinky returns as a result. This happens to many people who get out of the market without a strategy to get back in.

2. What if they were wrong?

If they were wrong (the market and/or real estate prices went up) they would likely conclude they’d missed the boat and wait for a”correction”. This is why so many investors stayed on the side lines after the 2008 debacle and missed out on the tremendous recovery in years 2009 and 2010.

Making the right investment decisions requires courage and bravery. If your time horizon is long-term, you have to make long-term investments even thought there is no certainty about the future.

The best way to make smart long-term investment decisions is to get clear on what your investment time horizon is and then make the best decisions consistent with the time frame. You can’t wait for the exact perfect time to do this because you’ll never know when such conditions persist.

Kathleen and Larry had a great deal of anxiety about the future. I understand and respect that. I wish I could have told them there will be a time in the future when it will be easier to make long-term decisions. Unfortunately, I’ve never experienced one of those periods. The future is always uncertain. At least that’s been my experience over the last 29 years in the business.

Many people have a very pessimistic view about the future. They could be right. There is plenty to worry about. But here’s why I think it’s a mistake to give in to that pessimism:

1. If they are right and the world falls apart, they won’t be able to retire anyway. They’ll have to buy a farm and guard it night and day. Kathleen’s business won’t be worth a dime anyway and neither will the money they have in the bank.
2. If they are wrong they will have squandered precious time to build a healthy flow of passive income which is exactly the opposite result of what they really want to do.

I don’t know if this is the best or worst time to invest in real estate, the stock market or anything else for that matter. I don’t think there is a “knowing” when it comes to this. But putting off decisions just because you don’t “know” has its risks too.

This is not to say that you should “buy and hold” your investments. While this might be a good strategy for some people, it’s not one I use or recommend. But no matter what your investment strategy is, your best course of action is to get clear of your goals, use an investment method that fits your needs and comfort level and then execute without second guessing or being paralyzed by fear of the future.

What is your best money tip on how to make smart investment decisions?