People want what they can’t have. It’s human nature. But human nature is often at odds with sound investing.
We may feel highly evolved as a species. The truth, however, is that our brains are still largely primitive. They unconsciously force us to think in terms of fight or flight.
When it comes to investing, our brains compel us to avoid the pain of losses and to seek the pleasure of gains. Here’s the problem: That’s simply not possible.
High returns with no risk is the holy grail of investing. Unfortunately, it will never be found. Risk and reward are tightly bound at the hip. Where high returns dwell, so lives risk. Our brains hate it. But like it or not, it’s reality.
As a result, we have three choices available to us as investors. We can have all of the good and all of the bad. We can have none of the bad and none of the good. Or we can have some of the good and some of the bad.
What we desperately want, but absolutely cannot have, is all of the good and none of the bad.
In order to get all of the good – in other words, great returns on our investments – we must accept the bad that comes with it – the chance of loss.
You see it in the stock market all of the time. Stocks are one of the highest returning assets available to us, but occasionally they lose big. A couple of times in a 50-year span you can count on stocks to lose 50% of their value. You can’t have the high returns of stocks without the 50% drops.
Some people get so anxious with the prospect of seeing their investments fall in value that they shun risky assets, like stocks, altogether. And that’s a respectable choice. You can avoid big drops in value. With super safe investments, like savings accounts and CDs, you can avoid all chance of loss. But you also relinquish the opportunity to earn higher returns. In other words, you can avoid all of the bad as long as you are comfortable with forgoing the good, too.
If neither of those options suits your taste, then join the majority of investors who are willing to accept some of the good while simultaneously stomaching some of the bad. It doesn’t have to be all or nothing.
For most of us, there is some threshold of pain we are willing to withstand when it comes to losses, as long as we get to feel the more periodic pleasure of gains.
That is exactly why understanding the proportion of your portfolio invested in stocks is so crucial.
Stocks power growth and gains over time, but they also invite risk of loss to the party. The more stocks you add to your portfolio, the higher your returns should be over time. But more stocks also mean more risk.
If seeing your account lose value makes you sick to your stomach – which is a completely natural feeling – then it may make sense to reduce the amount of stocks you hold in your portfolio. There’s nothing wrong with that. Just understand that you must also accept lower returns over time.
And you can make adjustments as you go along. Your choice isn’t static.
For many investors, the best path is to take all of the good and all of the bad early in life. Then, as retirement approaches, accept a little less of the good to avoid a little more of the bad. There may even come a time that it makes sense to avoid all of the good in order to avoid all of the bad.
So, pick your poison. But choose wisely.
This is the most important decision you can make as an investor.