Chuck Jaffe: Ask yourself some questions before investing
BY CHARLES JAFFE Market Watch
Wednesday, December 26, 2012
12/26/12 at 2:47 AM
If you want to avoid less-than-ideal investment decisions, ask a lot of questions - and not rhetorical ones, either.
In writing about stupid investments for the last decade, I talked to plenty of average investors who were stuck with stinkers and who couldn't remember exactly what they were thinking or expecting when they made their purchase decision.
It's hard to answer the question, "Would I buy this again today?" - an easy way for most people to evaluate whether it's worth hanging on to something they own - if you are flummoxed about why you bought it in the first place.
Lacking that initial detail, it's easy to either stick around too long or to knee-jerk your way out; neither is an ideal outcome.
Moreover, if you put your thinking into writing, it may force you to realize that you need to consider before investing that there's more downside risk or potential problems than you first thought.
If you still want to invest after answering these six questions, chances are good that the investment fits your profile and is appropriate for your risk tolerance. If you look back at an investment and see that the answers no longer apply - meaning you would not make the same investment again today - it's time to consider making a change.
1) Why?: You need a solid investment thesis for purchasing an investment or getting involved in a program. Include both your specific reasons for buying the security as well as your personal reasons. Conditions and circumstances change. For example, a young investor might be interested in a mutual fund with a low investment minimum; years later, as assets have grown, the account size is no longer a consideration. Likewise, as investors age, their objectives change.
2) Why now?: It's important to know what attracts you, the things that make you say, "I want to own this." Maybe it's a high rating from Morningstar or Lipper, or a tip you heard on television, or maybe it's a low price-earnings ratio or a high yield.
You could put your money anywhere, so figure out why something particularly stands out to you right now. If you don't have good reason to buy now, maybe you shouldn't.
3) Why not?: Play devil's advocate and examine the other side. If there's a case to be made against an investment, make it. If it feels hollow and unlikely to you, that's good - move on.
4) What do I expect to happen?: Don't be Pollyanna, but lay out what you would expect to happen in an ideal world. Maybe you expect performance from a mutual fund that is in the top 25 percent of its peer group over the next five years, or a consistent, stable yield from a stock. Framing your expectations helps you make sure the investment can meet them.
5) What would make me satisfied/dissatisfied?: This is about how you will measure your progress/happiness in the future, but it also helps tell you in advance if something will be worthwhile.
If the mutual fund can't be in the top quartile, for example, but is above average for its category, you might be OK with it; if it lags both your expectations and its average peers over, say, 18 to 36 months, you might be unhappy enough to sell.
Likewise, if your dividend-stock delivers its yield without significant price appreciation, you might be satisfied. A dividend cut, or a significant price drop that more than wipes out the plus of the dividend yield, conversely, would be a problem.
6) What's the worst that could happen?: Identify the worst-case scenario before you buy and you will know if you are actually willing to face it. Moreover, if it ever starts to occur, you will be more likely to watch for it, and recognize it if it starts to happen.
In the end, if your answers leave you more scared or undecided, going ahead with the purchase would be a less-than-ideal decision. That would be a stupid investment.
Original Print Headline: Ask yourself some questions before investing
Chuck Jaffe, senior columnist for MarketWatch, can be reached at firstname.lastname@example.org or at Box 70, Cohasset, MA 02025-0070.