Thumper used to say at his mother’s admonishing, “If you can’t say anything nice, don’t say anything at all.” Our mothers also admonished us with adages like, “If it sounds too good to be true, it probably is.”
That is wise counsel when it comes to investing. There are some fundamental truths about investments. Tenets that stand the test of time – every time. They are:
- There is a trade off between risk and return. The higher the return, the greater the risk.
- Diversification is essential to mitigate risk.
- If it sounds too good to be true, it is.
Certificates of Deposit and Treasury Bills/Notes pay interest rates that are considered to be the risk-free rate of return. Therefore, any investment that provides a higher return must, by definition, have more risk.
A recent advertisement in the business section of the local newspaper promoted a “safe and stable CD alternative” paying a 4% interest rate. It is easy to believe that at that rate, the risk should not be so great as to give cause for concern. But with current CD rates yielding 2% at best, flashing lights and ringing bells should warn of the need to read the fine print.
At the other end of the risk spectrum are penny stocks and private equity. It is easy to recognize the risks of illiquidity and volatility in these types of investments. They can sometimes generate outsized returns. However, their values can also go to $ZERO. We won’t even talk about investment strategies that involve leverage.
Swing for the Fences
A baseball analogy applies here. Investing in penny stocks is like swinging for the fences, trying to hit home runs. Babe Ruth hit a lot of home runs, but he was also a leader in the category of strikeouts. It is tempting to try to be the hero and swing for the fences by investing in hot stock tips and exotic investment programs – especially if your portfolio is in need of recouping from deep declines.
But just as in baseball where a solid strategy of hitting singles and doubles proves to score winning runs, it is likely more profitable to follow a well diversified investment strategy using conservative asset allocation and broad diversification.
So, how does a good financial steward discern truth? John 8: 31-32 instructs us to, “continue in my word..and you will know the truth and the truth will set you free.” Analyze investment offerings with common sense, remembering that if it sounds to good to be true, it probably is. Seek help from professionals who strive to, “gain in learning…acquire skill, to understand a proverb and a fugure.” (Prov 1: 5-6) Find a trusted advisor who you believe will act in your best interest at all times.
Godspeed in your effort to be a good financial steward.