Not all investments turn out positive. That might not be what you want to hear, but it’s true. Bull markets don’t go on forever, despite us wishing they would. Even if you’re investing in index funds, they can turn negative. No matter how good an investor you think you are, you can still make a mistake and lose money. How can you avoid making investment mistakes? What do you do when an investment turns bad ? What should you be thinking about when making that new investment?
My recent summer vacation was an idyllic time, spent with my family and some close friends. We spent it in our new beach house, on a little island off the French coastline. I was with my two little Chief Money Men and Mrs CMM and I was starting to think of ways I could extend my vacation time indefinitely when I got an email from a fund manager of a SPV (special purpose vehicle) I used to invest in a FinTech start-up.
The news was gloomy.
The CEO of the FinTech I was invested in, up and applied for liquidation and it was accepted. My investment had gone from high 5 figures to nothing, or potentially nothing, depending on the legal outcome in the next few months. It was an unpleasant read and then an even more unpleasant exchange of emails as I sought to learn more, from the fund manager and the CEO.
Needless to say it put a damper on the end of the vacation and quickly all notions of being indefinitely on vacation dissipated. It also got me thinking of all the prep work I had gone through and if there was anything I could have done differently to avoid this situation. Here below are my musings on some of the things to do to avoid Investment Mistakes and that sickening feeling in your gut when you lose a lot of your hard earned money.
1. Always do your research and don’t rely on others to do it for you
The very first thing to do when contemplating nay new investment is to study all the quantitative and qualitative information that you can get your hands on. This is the necessary base of understanding for any investment, be it a stock on the market to a rental real estate purchase: do your research.
By that I mean read what you are given and make certain you understand it. Don’t just gloss over it on the understanding that a lot of smart minds took time to pull it together or be biased by the number of other people investing in the same asset.
Understanding what you are reading, or what you have been given, means that you are able to explain it to someone who has no notion of investments in a simple and understandable way.
I have a few friends who are not particularly sharp on the investment side and they tend to be my yard-stick. If I can explain complex investments in a way they can understand, then I call that a win.
However, don’t only rely on what you are given. Look at collaborative studies, data, projections that can help you assess whether the information you have received is viable and makes sense.
Try to get your hands on studies that confirm the base assumptions included in the information you receive.
Seeing converging conclusions from separate data sources will get you more comfortable that there is latent demand for the product / company you are buying into and, also, that there is good long-term growth potential. That’s essential when buying any investment.
Also don’t forget to analyze and understand the tax regulations for the investment to be certain any upfront or deferred tax benefit is real.
Another tool to use to understand investments is to build super-simple Excel models.
2. Build your own financial model – even a basic one
Though I detest Excel, I haven’t found anything better, so I still use it to model investments I’m considering. I don’t do anything complex. It is just about modeling cash flows and trying to establish various return indicators that can tell me if I make more money than I spend on the investment. It may even be to list out Price/Earnings ratios or revenue growth rates, whatever indicators might seem fitting for the investment being considered.
The next step is to compare the amount I could possibly make against what I would make if I put that money in a low risk asset, like government bonds.
Obviously, you want to make more than the low risk asset, but you need to assess the risk inherent in the investment you are buying and Excel is a great tool for that.
3. Ask your ‘what if’ questions and model your potential downside
To model potential downside and risks, you first need to ask the ‘what if’ things go wrong questions.
Most of the time financial advisers don’t respond well to these questions
I ask myself the ‘what if’ questions and try assess reasonable downside scenarios. With my FinTech investment, I never considered the likelihood of a sudden liquidation given the cash flows seemed so robust and why would a CEO just liquidate his company if he had enough committed funds to keep it moving on. This was my mistake. Not easy to see or plan for but a mistake nevertheless.
Always make assumptions about downsides that you think are likely and then ask yourself if you can accept those downsides.
Never invest in something risky if you’re not willing to lose all the money being invested.
4. Read the fine print
All investments come with reams of data, even investing on the stock market comes with annual reports, stock analyst reports and the like. You don’t sign a contract for a stock market investment, as it is implied, but in my case I signed a contract. You need to read all the data to understand the intricacies of what you’re signing up for.
Always read the fine print, even if it takes some time. you don’t want to deal with surprises or hidden fees after the contract has been signed.
5. If in doubt consult with a specialist
Consulting with a specialist doesn’t mean spending loads of money on an outside firm looking at the fine print, building models and stress testing everything. Consulting with a specialist could be to discuss a project and to understand what are the usual things that can go wrong in the particular type of investment you are exploring.
With stock or bond investments, data is easily available and often speaking to a broker or experienced friend might be enough. With more unusual investments, it’ll be worth your while to speak to someone with more experience.
6. Work out your break-even point
When I modeled a downside case, without having all the probable downside scenarios, I simply assumed a case where the asset generated no cash inflows. I then looked at when my cash break-even was.
Break-even analyses are important as they help you understand how long you need to hold an asset for and hence what time risk you are, by definition, taking on when buying the investment.
Generally, the shorter the break-even the better.
7. Update your analysis when circumstances change
When the winds of any investment start to change, get a second opinion and then change your analysis. Both on the up and down-side.
If in doubt, at any point in time, that you have not covered all the possible ‘what if’ questions, get a second opinion and have someone else play devil’s advocate. It is amazing how someone outside the immediate situation can often have better clarity of vision or be able to ask a simple question which might get you to see your investment differently.
8. Don’t panic but don’t sit still either
Not advancing is never a good option. Putting something aside and waiting for things to resolve themselves doesn’t work.
You don’t need to win the sprint as often it is about running the marathon, so best to keep yourself moving forward at a slow steady pace. Slow and steady also means you have time to assess and digest new information, which saves you from having a knee-jerk reaction to something new.
Remember to update your models and keep assessing the impacts of changes to circumstances.
Knowing the current state of your investment is paramount to knowing when or if you finally pull the plug and lock in your loss.
9. Lock in your loss when you have no other options and move on
There may come a time when you run out of options to get your investment back on track and this time is usually when you have advanced as far as you can and have no further options left to explore. Or it could be when the options to explore and the cost of those options outweigh the value you can get back from your investment.
When you get to the stage where the cost of maintaining or recovering your investment outweighs its current value then you need to lock in your loss and walk away.
Losing money is not inspirational. Losing money is not fun.
But losing money can teach us valuable insights about making money.
Want more simple tips and insights? Check out my friends at Finimize. Disclaimer: If a lot of you sign up for their newsletter, I might just be able to have a coffee on you at the end of the week!