I’m not a very good golfer, so every time I prepare for a shot I ask myself: What’s the worst thing that could happen? Sand trap? Water? Trees? I base my club selection and flight direction accordingly. It’s a good question to ask when you’re faced with an investment decision as well. What could go wrong? If you think through the risks involved, you are less likely to make costly mistakes.
Here are some of the most common “worst case” scenarios to avoid.
Waiting to get back to break even
I hear this far too often: “I’m going to sell this stock as soon as it gets back to where I bought it.” What’s the worst thing that can happen? The stock never returns to breakeven but instead it keeps spiralling down to zero. Yes, that can happen. Think now long-gone companies like Bre-X, Nortel, Enron, and all the others, once market darlings, that ended up in bankruptcy proceedings.
If a stock is down, ask yourself why, and realistically consider the outlook going forward. National Bank of Canada (TSX: NA) is down about 11% from its 52-week high, but the odds are pretty good it will eventually regain that level and move higher. Valeant Pharmaceuticals Inc. (TSX: VRX) is down about 90%. The odds of it recovering to the 52-week high of $347.84 are slim to none. It’s more likely to fall to even further.
Succumbing to the lure of a high yield
Any time you come across a stock with a yield of 8% or more, it should set off alarm bells. The market doesn’t give money away. The stock is offering a high return because investors are convinced there is something wrong with it: The company is about to cut the dividend, or come out with a bad earnings report, or whatever. The worst thing that can happen in this case is that the market proves to be right.
Investing in a “story” stock
The brokerage world loves to sell great stories. These are stocks that are based on a terrific new concept – maybe the first company to commercially market virtual reality products to consumers. But so far, it hasn’t sold a single unit or banked a penny in profit. What’s the worst thing that can happen? Think back to the tech crash of 2000-02. Hundreds of great concept companies crashed and burned, wiping out billions of dollars in valuations.
Overexposing your portfolio to the stock market
“I’m really angry with my broker. My portfolio has lost 25%.” Maybe it actually isthe broker’s fault. More likely it’s a case of inappropriate asset allocation. The older we get, the less exposure we should have to the stock market. Some readers have written to argue this point, saying that’s the only place they have a chance to earn a decent return, with interest rates so low. That’s true, but what’s the worst thing that can happen if you overweight stocks? You lose 50% or more in a crash.
I’m not advocating perpetual pessimism when making investing decisions. I amsuggesting taking some time to carefully consider the risks before plunging in.
Courtesy Fundata Canada Inc. © 2016.Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher ofThe Internet Wealth Builder andThe Income Investor newsletters, available through his BuildingWealth.ca website. This article is not intended as personalized advice.
