7 Investing Assumptions That Can Hurt You
Too many investors get lured into believing certain actions will win them big money in the stock market. These actions are typically based on various assumptions not based on facts, and they can wreak havoc on your overall financial plan.
At Linscomb & Williams, wealth management is what we do. Below we share 7 investing assumptions that we've seen which can hurt you – as well as tips to avoid acting on these assumptions.
Assumption #1: If a Stock Price Dips, That Means the Company Isn’t Doing Well
Don’t assume something is wrong with a company just because its stock price dips. Market moves aren’t necessarily always rooted in performance, and therefore, a declining stock price shouldn’t automatically be a red flag.
There are often external forces at play that cause a price to dip. The best approach is to stay level-headed and use this as an opportunity to practice patience. Review your initial reasons for making the investment. If anything, this may be a good opportunity to buy more shares while the price is low.
Assumption #2: Hot IPOs are Great Moneymakers
Zoom, Airbnb, Beyond Meat – everyone wants a piece of the IPO pie. But a high valuation and market excitement doesn’t automatically equal success.
For every one company that goes public, there are dozens (if not hundreds) that completely fail. Take Munchery for example. It had a $300 million private valuation but abruptly shut its doors in 2017 before it even had a chance to go public.
Lyft was one of the most highly sought-after IPOs of 2019. On the day it went public, shares sold for $71 apiece. The stock price quickly plunged to $42 after the company was hit with a lawsuit and questions were raised about its profitability.
Lyft isn’t the only story. Uber shares dropped 7 percent on the first day of its IPO. Peloton dropped by 11 percent. The We Company, which owns WeWork, quickly pulled its IPO right before it was set to go public (even though it had a high initial expected valuation).
The bottom line? Don’t get enamored with IPOs. They don’t always lead to higher returns. If you hear speculation about an IPO opportunity, discuss it with your financial advisor.
Assumption #3: Blue-Chip Stocks are Always Safe Investments
People assume that large companies considered blue-chip stocks are safe, long-run bets. While this is often true, it’s not always the case. Remember, any stock can decline – even the stocks of major companies.
Take PG&E Corp for example. After news came out that its equipment was responsible for the California wildfires, the stock declined sharply. Now, the company is battling bankruptcy.
One share of PG&E stock cost $70.08 in August 2017. When it released news about its faulty equipment, the stock dropped to $7.23 by January 2019. Surely PG&E shareholders could not have predicted an 89 percent drop in the share price.
This is a good example demonstrating that scandals and other bad news related to liabilities can take down any company (even the big ones). The best way to hedge against these uncertainties is to diversify your holdings.
Assumption #4: Once a Stock Increases Significantly, It’s Time to Sell
Many investors have a preconceived idea when they invest of how much a stock could increase. If it increases to this limit, they assume it can’t possibly go any higher. As a result, they sell the stock for a profit and move onto something else.
But what happens when the stock price continues to rise? Seller’s remorse kicks in as you realize you could be enjoying even larger gains.
Warren Buffet bought 100 million shares of Coca-Cola for $1.299 billion dollars in the 1990s. As of November 2019, these shares are worth $20.7 billion – a 1,493.53 percent increase! He likely was not initially predicting a 16-to-1 return over 20 years, but he has continued to evaluate the merits of an investment in the company as the share price has climbed.
Discuss your portfolio with your financial advisor. It may make sense to hold onto a stock, even when it’s experiencing more growth than you ever thought it would. As long as its growth is matched with strong company earnings, a financial advisor can help you avoid the temptation to sell prematurely.
Assumption #5: It’s Possible to Time the Market
Even Warren Buffet doesn’t try to time the market. His Coca-Cola stock holdings are proof that a long-term investment strategy can be very profitable. Market timing is almost always a fool's errand.
A recent Dalbar study shows that in 2018, the average investor lost 9.42 percent investing in funds that primarily diversify among companies in the S&P 500 – but the market itself only dropped by 4.38 percent. Decisions to buy and sell at the wrong time accounted for the shortfall in performance.
Statistics from 1998 to 2015 confirm a similar pattern. The S&P 500 averaged an 8.19 percent return, but the average equity mutual fund investor enjoyed a 4.67 percent return. If those same investors would’ve put their money in a passive index that tracked the S&P 500 and simply remained invested, they would not have lost out on 3.52 percent of growth.
Assumption #6: If Everyone’s Buying a Stock, It Must be Good
When you see your friends, neighbors and colleagues investing in certain stocks, it can be tempting to get in on the action.
Remember the Dot Com era of the 1990s? Everyone was buying tech stock. It’s all you heard about in the news, at work, at home and when running errands around town. As a result, more and more people bought tech stocks and the price became inflated. Pretty soon the price got so high that no one wanted to buy it anymore – and that’s when the bubble burst.
The same thing happened with the real estate boom in the mid-2000s. The lesson? Just because everyone’s buying something doesn’t mean you should necessarily buy it too.
Assumption #7: Stop Investing if We’re About to Enter a Recession
If you listened to economists back in 2012 and again in 2015 when they said we were about to enter a recession, you’d still be waiting to invest. In fact, the opposite happened. The S&P 500 almost doubled from 2012 to 2019. If you’d listened to those warnings, you could’ve missed out on unprecedented returns.
It’s important to remember your long-term goals. If the financial services industry is not your area of expertise, reach out to a financial advisor. Emotions are especially high as we navigate life during and post Coronavirus. Don’t make an emotional decision that has long-term effects.
How to Invest Wisely (And Avoid These Assumptions)
Humans are emotional. Even if you tell yourself you won’t react a certain way when your portfolio dips, your emotions can take over the driver’s seat. Investing can be challenging to our emotions. Because of this, you may not want to invest by yourself.
A Vanguard study concludes that those who work with a financial advisor enjoy 3 percent higher returns on average than those who don’t. Why? Because a trusted financial advisor helps you:
- Stay in control of your emotions
- Make investment decisions that align with your needs and goals
- Make investment decisions that are tax-efficient
In other words, financial advisors help you avoid these 7 common investing assumptions, so you can reach your financial goals. At Linscomb & Williams, we welcome the opportunity to help you grow, manage and protect your wealth. If you’d like to learn more about Linscomb Williams’ wealth management, financial planning and investment services, contact us and get the conversation started.