For all of us, two of our primary concerns in life are maintaining our standard of living, both financially and in regard to lifestyle, and caring for our families. At different stages in our lives these concerns are defined in varying manners.
Regardless of what stage you are in life, generally the following three factors must be considered prior to making a decision, financial or otherwise. These factors must be considered because they will impact the two primary concerns noted above. They are risk, reward and the probability of a particular outcome.
First, identify the potential consequences of an action along with the consequences of inaction. Then, ask yourself, “what is the potential RISK of this action (or lack of action) relative to the REWARD (return) you are going to receive or what you intend to avoid. Furthermore, by taking action what is the PROBABILITY of the intended result being realized?”
As these three factors pertain to investing and phrased in a similar manner to the question in parentheses above, but with particulars added, consider the following.
Investors must ask themselves, “What is the risk of subscribing to the belief that the stock market is not the appropriate vehicle for your long-term investment needs due to the fact that over the past decade it has gone nowhere?” The risk is that you are wrong and that the American Economy and therefore the U.S. Stock Market will eventually recover from this malaise. However, you will not participate in this growth as your investments will be out of the market. Furthermore, even if you are correct in your belief, over a long period of time there is not a direct corollary between stock market returns and the performance of the economy where the specific company is domiciled. For example, the Japanese economy has been mired in a slump for the past two decades and yet, prior to the “unintended acceleration” scare, the stock of Toyota Motor Company performed very well.
Conversely, investors should also ask, “What is the reward of over-allocating assets on a percentage basis to stocks relative to the risk that I am willing to take?” Given the low interest rate environment in which we are and will most likely be living in over the next year or so, investors into fixed-income instruments like Certificates of Deposit and Bonds are searching for more income and growth. Some wisely and others unwisely have begun to shoulder portfolio risk by investing into the stock market and as a consequence have reduced the predictability as well as the probability of a specific outcome.
Finally, ask yourself, “what is the cost of being wrong relative to the benefits of being right?”