Our experts answer readers’ investing questions and write unbiased product reviews (here’s how we assess investing products). Paid non-client promotion: In some cases, we receive a commission from our partners. Our opinions are always our own.
The author, financial planner Martin A. Scott.
Martin A. Scott
I received bonus-like compensation at a job in my 20s and knew I should do something with it.
I asked a bank representative for help, and they ended up selling me mutual funds.
When the stock market dropped, I pulled my money out because I didn’t know any better.
At my first job out of college over 20 years ago, I received bonus-like compensation from my employer.
It was not a substantial amount of money, but was definitely enough for it to be considered a “cash windfall” given my age and financial situation at the time. Keep in mind that this event in my life occurred many years before I became a financial planner and understood how investing really works.
Obviously, I was happy to receive this type of compensation and knew I had to do something with it, but I wasn’t sure what exactly to do. As a financial planner today, I think about all types of investing implications, like risk tolerance, asset allocation, fees, and taxation, but at that time in my life, I didn’t consider any of those things.
I asked a bank representative for investment advice — my first mistake
So what did I decide to do with this sudden increase in money? I decided to go to the place where my money was located: my local bank. I told the bank about my new financial situation and they had me meet with a bank representative whose job was to help me invest the money. This person did not provide me with any real investment advice. Instead, he just sold me mutual funds to invest in.
So here I am with an investment portfolio of mutual funds that were explained to me, but I still did not really understand them. Fast forward a few months, my investments in these mutual funds began to significantly decrease because of a severe downturn in the stock market. Now I have no idea what to do. I am watching my investment value decrease. I had no real plan for the money. I had no real financial advisor to call to discuss investment strategy because the bank representative was really just there to sell financial products.
Unfortunately, I let fear set in and ended up selling out of all my positions. My story is a perfect example of a situation where someone simply lacks an understanding about investing and makes an expensive mistake. Given my extensive knowledge of financial planning and investing now, it seems crazy to me that this is what I did over 20 years ago, but so many lessons can be learned from this story of mine.
2 investing lessons my story can teach
Personally and professionally, I believe there are two major lessons that can be learned and applied from my story.
1. Take the time to understand all the implications that come with investing
As noted above, investing implications include knowing your own risk tolerance, optimal asset allocation, what you are paying in fees, and how taxation impacts your investment.
If an individual decides to hire an advisor to manage their investments, then it is absolutely necessary for this advisor to address all of these items and make sure the client has a full understanding of them. However, if someone makes the decision to invest on their own or use a robo-advisor, then it is still very important for the person to be knowledgeable of these implications.
Either way, when a person is knowledgeable of how investing really works, it will not guarantee certain results, but it certainly provides an individual the proper tools to have success with their investments.
Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three fiduciary financial advisors in your area in minutes. Each advisor has been vetted by SmartAsset and is held to a fiduciary standard to act in your best interests. Start your search now.
2. Don’t allow fear to dictate your investment decisions
This lesson stems from how important it is for a person to know their own risk tolerance, which is how much a person is willing to lose within their investment portfolio. There are many factors that go into evaluating risk tolerance, which include an individual’s age, time horizon of the specific investment, and overall financial position. Take the following hypothetical example of how knowing risk tolerance helps alleviate fear and can lead to more sound investment decision making.
Mary receives a large inheritance from her late grandmother and decides that she wants to use it for income in retirement, which could be approximately 25-30 years from now. She has a very high tolerance for risk because she already had a solid financial situation prior to receiving the inheritance and also has no plans to use this sudden cash windfall until her retirement.
Mary hires a financial advisor who constructs an investment portfolio for her to invest the inheritance. Her portfolio steadily grows every year for the first three years, but in year four, the stock market goes through a severe downturn, which results in Mary losing 20% of her investment value. Mary is clearly not happy with the negative performance of her portfolio, but talks with her financial advisor who reminds her about the very high risk tolerance she indicated when she first started investing. As a result, she does not let fear set in (i.e., Mary did not sell out of her investments) and stays the course with her investment plan knowing she has a long time horizon for her investments to recover and ultimately perform very well in the long-run.
This article was originally published in September 2021.