• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar

Wealth Pilgrim

No Money Worries. No Matter What.

Neal Frankle featured in
  • Home
  • Life Insurance
  • Investing
    • Build Strong Investment Building Blocks To Avoid Going Broke In Retirement
    • Systematic Mutual Fund and ETF Investing
    • Stock Market Investing Guide
    • Choosing the Right Investment Brokerage Guide
    • How Bonds Work Guide
    • How Banks Really Work Guide
    • Annuities – What You Need To Know Before You Invest
    • A Beginners Guide To Buying Individual Stocks
    • Create A Pool Of Great Mutual Funds and ETFs To Pick From To Secure Your Retirement
    • ETF and Index Fund Investment Guide
  • Earn More
  • Banking
  • Retirement Planning
    • Retirement Guide
  • Ask Neal a Question
  • Reviews
    • Upgrade Personal Loans Review
    • Lending Club Review
    • Prosper Review
    • Ally Invest TradeKing Review
    • CIT Bank Review
    • LegalZoom Review
    • Lexington Law Review
    • Airbnb Host Review
    • Should You Drive For Uber?
  • Tax
  • Courses
    • Raise Your Credit Score So You Can Buy a House – Free Video Course

Why Really Smart People Lose Money

by Neal Frankle, CFP ®, The article represents the author's opinion. This post may contain affiliate links. Please read our disclosure for more info.

ben-bell-5

Please look carefully at the picture of the bell curve above. It is  the key to understanding why most people lose money investing.   The good news is that once you understand this picture it can help you avoid making catastrophic investment mistakes.

Don’t worry. This isn’t a statistics lesson. But even if it were, you know a lot more about statistics than you think.  In fact you draw these bell curves all the time…at least in your mind. But you may not be doing it correctly.

Let me show you what I mean.

Let’s say you are considering making an investment in a mutual fund. You look at  the fund performance over many years and there is plenty to like.  You find that over the last 20 years, it had a number of great years.  And you perk up even more when you see that it returned a profit of 30% or more several times. At the same time you notice some bad news.  During the worst years investors lost  30% or more.  That also happened a number of times.

That being the case, you could draw a bell curve like the one I created above. If you did draw that bell curve it would accurately describe the past performance of this hypothetical fund.  Most of the returns fall between +30% and -30%.   And if you were a statistics freakazoid, you could conclude that if you buy this fund, your returns will fall between  +30% and =30%  95% of the time. If you did come to such a conclusion, you’d be right.

The Problem

The problem is that you’ve failed to address the other 5% chance of an outlying event occurring otherwise known as “the tail”.  Sure you acknowledge that there is a 2 1/2% chance of something really great or really awful happening intellectually.  But in your heart, you dismiss it.  “It won’t happen to me” is what you tell yourself.

Of course, the 2 1/2% to the right of +30% is wonderful. It represents those years when the return exceeds 30%.  According to our bell curve, that’s going to happen 2 1/2% of the time.

But 2 1/2% of the time, the performance will be much worse than -30%. Yikes! 2008 was one of those years. Need I say more? The reality is that these “bad surprises” are a possibility and nobody can predict how “bad” they might be or when they might occur.

The Big Problem

Some people make the mistake of forgetting about the extremes as I mentioned above. Others think that once the extremes happen, those extreme returns are the new norm. Both of these conclusions are flawed, dangerous and expensive.

If the market tanks and you decide to never invest again, you’ll be selling low and forgoing any potential for future growth.  You also potentially jeopardize your financial future and retirement.  Ouch.

When your investment returns fall into the right tail, it’s equally as dangerous to expect those sky-high returns to repeat themselves year after year.  You might chase return without considering risk.  Some day that chicken will come home to roost and you’ll be the one who gets cooked.

So what is an investor to do?

Do you want some help making better investment decisions?  Do you have investment questions?  Why not considering connect with me.?

1. Be clear on your financial situation and time horizon.

Create a portfolio allocation based on your real time horizon. Say you are 57 years old and you want your money to last until you reach 85 years of age.  What is your time horizon? It’s 28 years. Even if you get clobbered with a terrible market, it may not mean that much in your overall plan.  Don’t make the mistake of changing your time horizon when things get difficult and uncomfortable. That usually works out to be a very costly mistake.  Acknowledge worst-case scenarios and be willing to accept them or use an investment strategy with less risk.

2. Use the right asset allocation to reduce risk.

It’s very dangerous to take on more risk when things are good and suddenly become very conservative when things are bad. Select a portfolio allocation that will pass the “sleep at night” test in tough situations. This will allow you to stay invested longer.

3. Understand that things may not work out as you planned.

If you get caught in “the tail” too soon or too long, your plans may not work.  The chances of this happening are low – but they are there.  If you build your whole investment strategy as if the worst will happen, you’ll be ignoring the other 97 1/2%  chance that things will be much better.  That’s like staying inside all day because of the slight chance you might get hit by a bus.  Is it possible?  Yes.  Is it likely?  No.

And if you do get hit by a “financial  but”, you  still have options.  You can reduce spending and/or work longer. If that happens, it doesn’t mean you made a mistake. You could have made the best decision possible with the information you had available and things still could have turned out poorly. Have a “Plan B.”

Don’t get me wrong.  I believe that you can and should use an investment strategy that recognizes risk and adjusts your portfolio accordingly.  But no matter what you do, there is no guarantee that it will work.

Do you disagree? Do you think it’s possible to have a fail-proof investment plan? Are you willing to accept that your plan may not work out?

 

Tweet
Pin1
Share1

Reader Interactions

User Generated Content (UGC) Disclosure: Please note that the opinions of the commenters are not necessarily the opinions of this site.

Comments

  1. Neal says

    June 10, 2009 at 5:14 AM

    Thanks Ken. I have found that it’s very east to focus on the long term – when the market is going up.

    True Wealth Pilgrims need to keep this idea in mind when the going gets tough. Thanks for a great reminder.

    Reply
  2. Ken says

    June 9, 2009 at 3:57 PM

    Great post Neal..there is always risk involved in investing…we always need to understand it’s a long term mindset. I did pull some of my investments back in08 but only about 15%. I need to re allocate like yesterday.

    Reply

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Are You Human? * Time limit is exhausted. Please reload CAPTCHA.

Primary Sidebar

Who is Neal Frankle

Neal Frankle

I'm a CERTIFIED FINANCIAL PLANNER™ Professional with more than 25 years of experience. I feel very blessed and hope to share my personal financial experience and professional wisdom with readers of WealthPilgrim.
Read More »

Stay Connected

Facebook Twitter YouTube RSS

More Categories

Career Development
College Funding
Credit Cards
Credit Score Fixes
Money and Marriage
Debt Relief
Estate Protection
Property Investment Loans
Small Business Strategies
Spend Less Money

Disclaimer

Wealth Pilgrim is not responsible for and does not endorse any advertising, products or resource available from advertisements on this website. Wealth Pilgrim receives compensation from Google for advertising space on this website, but does not control the advertising selection or content. Please do the appropriate research before participating in any third party offers. The information contained in WealthPilgrim.com is for general information or entertainment purposes only and does not constitute professional financial advice. Please contact an independent financial professional for advice regarding your specific situation. Wealth Pilgrim does not provide investment advisory services and is not a registered investment adviser. Neal may provide advisory services through Wealth Resources Group, a registered investment adviser. Wealth Pilgrim and Wealth Resources Group are affiliated companies. In accordance with FTC guidelines, we state that we have a financial relationship with some of the companies mentioned in this website. This may include receiving payments,access to free products and services for product and service reviews and giveaways. Any references to third party products, rates, or websites are subject to change without notice. We do our best to maintain current information, but due to the rapidly changing environment, some information may have changed since it was published. Please do the appropriate research before participating in any third party offers.


About · Contact · Disclaimer & Privacy policy

Copyright © Wealth Pilgrim 2022 All Rights Reserved