Why Some Investments Lose Money and Others Don't
Are You to Blame for Your Loss or Was It the Investment Itself?
It's an unfortunate, but common investment scenario. You get a hot investment tip from a colleague, a friend, or maybe even your broker, and it sounds like a great opportunity to make some money. Since you can't pass it up, your invest some of your hard-earned money. Then maybe a few months later, or perhaps a few years later, your "hot" investment takes a nose dive and you lose a chunk of your hard-earned cash.
Or maybe you don't lose your initial investment, but you don't make anything either and you missed out on potential growth opportunities available elsewhere. What went wrong?
First and foremost, most "hot" stock tips should be passed up by the average investor, who should instead concentrate on investments with a nice, steady growth pace and low fees. Speculation (which is what most "hot" investment tips are) is for experienced investors who know the ins and outs of investing and who can afford to lose money if the "hot" deal turns sour. In the end, speculation can be a lot like gambling and like gambling, speculation is not for your retirement funds or your kids' college fund.
So why do some investments make money and others lose money?
Common Reasons Why Some Investments Make Money
When looking at stocks and bonds that have a history of strong and consistent performance, we see some patterns.
Though these patterns are not indicators of a risk-free stock market investment (those are few and far between and generally expensive), they do highlight some of the many reasons behind why some investments make money. To the speculative or risk-seeking investor (not the type of investor you want to be), there is very little magic or excitement behind solid investment choices.
In fact, most of the time it's just an indicator of good business.
- The company turns a profit consistently, so they can afford to pay the interest on your bond or the dividends on the stock you bought.
- The company's performance beats that of its competitors.
- You invested in a financially strong company that is widely recognized as being a good investment. You're more likely to receive a good price for your stock when you're ready to sell it if the stock is in demand and others want to buy it.
When looking for good investments, legendary value investors like Warren Buffet tend to look at these key considerations and many others from the company's management to the business itself to determine the value of the company and, therefore, whether its stock is undervalued (which may suggest a good investment opportunity). When it comes to investing and winning in the market, we must also always leave a little room for simple good luck, which is not a sound investment principle, but certainly not unheard of.
Common Reasons Why Some Investments Lose Money
Just as there are several reasons why some investments make money, there are just as many, if not more, for why an investment loses money. More often than not, there is some investor error lingering in the background of a failed investment.
Many investments lose money simply because of investor behavior. Whether the investor is trading too often or not often enough (which can be devastating to a portfolio), trying to time the market (which is generally a bad and losing idea), acting in accordance with crowd or herd think (which is generally wrong), or simply not investing according to an appropriate timeline (which can render otherwise good investments losers due to short-term volatility), investors are constantly losing money due to their own investing behaviors and emotions.
But when an investment loses money despite otherwise sound investing behavior on the part of the investor, reasons for the loss might go back to the company itself or unethical business practices.
- Consumers don't buy the company's products or services. It doesn't matter if they have great products. If they're not marketed well or they cost too much, sales will suffer.
- The company can't compete effectively in its industry.
- The officers of the company mismanage the business, perhaps by fraud or by failing to follow a budget, and their costs exceed their income.
- The stock doesn't appeal to other investors, so when you sell it, buyers are unwilling to buy it at the price you paid for it.
- The managers or officers of the company are dishonest and misuse the company's funds. Think Enron, Adelphia, or WorldCom.
- You fell for a pitch that was a lie - the company's profits are less than you were told, the contracts that were a "sure thing" never existed, or the financial statements were doctored up.
- Your financial situation forces you to sell your investment at a time when the market is down.
- Brokers who sold the stock manipulated the price and then dumped the stock, taking their dishonest profit, and leaving you and other investors holding a worthless or nearly worthless stock.
The Investment Lessons for the Average Investor
Ultimately, there are no bullet-proof investments or investment strategies, but there are behaviors that can save you from significant loss. In the end, good investments that make money aren't always the most exciting (in fact, they generally aren't exciting at all), but the key is to find the balance between the risk and reward and not make those common investing mistakes.