Taking an extreme position with our investments presents one of the biggest financial mistakes we can make. I often find myself meeting with people who are either 100% invested aggressively in stocks, or 100% sitting in cash. Typically, these extremes exist due to strong conviction in a likely outcome.
For example, the person sitting in all cash coming out of the depths of the 08/09 recession, certain another recession would shortly follow. Their extreme posturing caused them to miss out on thousands of points gained. Importantly, this likely caused significant goals to be missed. On the other end of the extreme, the lack of volatility we experienced the last several years saw many investors over exposed to equities and unprepared to handle a significant pullback.
The good news
*That the emotion driven financial media often fails to point out, is that you don’t have to operate in these extremes. Building an investment portfolio allows you the option to be 70% invested or 30% invested as examples.
We have to recognize the range of potential outcomes and build an investment strategy appropriately. This can often be difficult as emotions can take over! I like to remind myself of a few stories that keep me humble when I find myself feeling strong convictions about future outcomes:
“The Chernobyl accident is considered the most disastrous nuclear power plant accident in history, both in terms of cost and casualties.”
How could this happen?
We hear the question repeated throughout HBO’s miniseries, Chernobyl.
A combination of systems and checklists overseen by nuclear physicists, theoretically, should have been foolproof.
In fact, for most of the show, the scientists remain adamant that the plant’s core could not have exploded, despite clear evidence of the contrary. The explosion just didn’t seem within their realm of possibility.
And yet, a combination of system and user error reportedly caused the explosion.
Considered one of the greatest catastrophes in human history, the scientists’ delayed asking, “What if we are wrong?” This delay cost them valuable time for the recovery process.
Long Term Capital Management (LTCM) collapsed in 1998. The board of the prestigious hedge fund boasted two Nobel Prize winners and the former head of bond trading for Solomon Brothers – at the time, a prominent trading desk. The fund operated advanced models that made money exploiting complex inefficiencies in the various investment markets. Essentially, foolproof.
After three years of wild success, the fund went bankrupt.
How could this happen?
In 1998, Russia defaulted on their bonds. At the time, nobody thought that a sovereign government could possibly default on their bond obligations. Especially since they could print their own money. The fund’s model did not account for a default within its realm of possibility.
And yet, a Russian default happened, and Long Term Capital Management saw themselves on the wrong side of multiple trades. Their inability to question conviction in an outcome cost them to the point of bankruptcy.
How these Relate to Financial Errors
To show that even teams of the most brilliant minds make mistakes. And for many of us and our finances, it will likely be no different. Financial mistakes will happen. It’s humbling, yet powerful to accept the inevitability. One of the best ways we can mitigate the damage of financial mistakes is by asking ourselves, what if I’m wrong?
A few examples of common, strongly held beliefs that devastate if wrong:
- “The stock market is going to crash.”
- “I won’t live into my 90’s”
- “I’ll get to the estate plan later”
For each of these statements, I prompt the question:
“What if you’re wrong”?
It may not be possible nor practical to plan around every scenario. However I encourage you to address the outcomes that may have the largest impact on you or those you care about. Humbling ourselves through the financial planning process provides peace of mind. This is essential should something we never thought possible actually occur.
Not sure where to start? Get in touch. I’d love to help.