If you don’t understand it, don’t invest in it

Cryptic CrosswordPhoto courtesy of Ross Beresford

I took a new job last month, as I mentioned previously. While it is not in the finance industry, it’s in a space such that people often talk about financial transactions, venture capital, and especially about future developments in tech.

It’s a heady space, a strange mix of wonkery and Burning Man-esque fervor.

And lots of people are talking about the Next Big Thing, the new thing that you have to invest in.

Now, I’m not immune to temptation, of course. And I’m not immune to good ideas well presented and argued.

But I can’t get on board with a new company or idea mainly because on one fundamental investing tenet, one that you would be wise to keep in mind: Don’t invest in anything you don’t truly understand.

You’re invested in what?

When I’m coaching someone about their retirement account, I will have them pull up their recent statement of their 401(k), including their holdings.

So why are you invested in these particular assets?” I already know the answer, but I always ask anyway.

I don’t know.” A nervous, apologetic, smile. “There was a way for someone to just pick the best options for me, and I went with that.

Now, I have total compassion for those who are unfamiliar with portfolios and investing options; no one is born with investing knowledge, remember.

And when faced with a new job, it can be overwhelming to learn the ropes, set up health insurance, and also have someone thrust a paper with unfamiliar codes, telling you that this is vital to a future that’s decades away.

It’s the easiest thing to put off thinking about. Can’t I just check a box and let someone else make the decisions?

Not really

It would be great if we had a system in place where we wouldn’t need to worry about our ability to afford the last quarter to a third of our lives. Maybe a national pension scheme, or a more robust Social Security system.

But we don’t have that. We’re all basically on our own, in an institutional sense. You may have family and friends who will help you out (and I hope you do). But you are in charge of your own future.

That is both a blessing and a curse, but I’d rather you learn it as soon as possible.

Look to history

I love things with long track records. I know they say that past performance isn’t a guarantee of future results, but that doesn’t mean that you can’t learn anything from looking to the past.

Frankly, just having a past is a good indicator.

The S&P 500 has been around for over 50 years. The ability to buy into an index fund that tracks the S&P 500 has been around for over 40 years.

In short, this is not exactly a new operation. And while we don’t know where the economy is going to go, we know that it’s going to go somewhere. We have a lot of history to back that up.

So here we have an important point: The more consistent history a product has, the more weight that history carries.

To everything, learn learn learn

I mention the S&P 500 because it’s recognizable, and it’s relatively easy to fathom.

But there are approximately 6 zillion different funds one can invest in.

Actually, the number is more like 10,000 but it pretty much comes to the same thing.

And in the case of your prospectus from your employer, you may have only 10-50 of these options. And that in itself is overwhelming.

And they all have five letter codes too, making your investments look like a crossword puzzle encrypted in ROT-13.

(Read more about ROT-13…in ROT-13. This is my sense of humor, folks.)

Before you can move forward, you have to learn what these funds are doing. Here are some things to look for.

  • Learn the fund’s risk pattern and see if it matches your own desire of risk. Are you willing to endure more risk for greater returns?
  • Also, you need to look at the fund’s past returns. Over the past 10 years, what has its return been?
  • What are the fees associated with the fund? Any fee paid is going to cut into your returns, so this is crucial.

This topic is huge, and of course I’m just scratching the surface of it. And I’m not giving investment advice here.

What I am saying is that, in order to be a well-informed participant in your own investment schemes, you need to be able to fill in the following blanks for everything you own:

“I invest in _________ because it ______________.”

And don’t be sneaky. Don’t say “because it was recommended to me by my cousin/friend/Jim Cramer“. You need to be the one who understands. Just like in school, put it in your own words.

One small exception

Now, as much as I want you to know exactly what you are doing (I wouldn’t write about this topic week after week if I wasn’t passionate about it), I don’t want to stop you from taking action.

And while investing without knowing what you’re doing isn’t great, except in the most negligent cases (hi Enron!), in the short run, it’s often better than not investing at all. (At least if you can reverse the decisions that turn out to be poor.)

So even if you’re overwhelmed by your new job, sign up for the 401(k) anyway (especially if they offer a match). Put your money in something simple, like an index fund, or other all-in-one fund. Start simple. Do something. Don’t leave money on the table.

And then as soon as you can, do your research. This is your life, and you want to make sure you have enough money to not have to think about it that much.

But enough about me. Have you ever invested in something you didn’t understand?

Mike Pumphrey

Mike Pumphrey

I'm the founder and author of Unlikely Radical, a site to help people succeed with money, achieve their goals, and live intentionally.

I offer a free phone consultation to anyone who is interested in changing their financial narrative. Are you ready? Click here for details.
Mike Pumphrey
Posted on October 9, 2017