Most people who have spent any amount of time around college towns or night clubs are familiar with the phrase “beer goggles.” Simply put, this phrase refers to a general tendency for people who have been drinking alcohol excessively to develop highly distorted perceptions of other people’s attractiveness. In these situations, many people find themselves making romantic advances toward people whom they would not be interested in if they were sober.
Fortunately, most people mature with age and grow out of the propensity to don “Beer Goggles” when finding their spouse. As we gain more experience, the importance of intelligent decisions becomes increasingly apparent. The decisions that we make in regards to our education, career, and spouse all have long-lasting impacts on our life. Thus, it is not difficult to see why making these decisions with a sober mind is of paramount importance.
Unfortunately, there is a distinctive sector of life where many people bring back the “Beer Goggles” in full force. This part of life is investing, and many people allow themselves to become inebriated by promises of high returns that lure them into deals that are much less attractive when viewed with sober eyes.
Consider all of the late-night infomercials that you have seen, soliciting you to purchase a system that will teach you to “Buy Real Estate with No Money Down” or “Grow Wealthy with FOREX Currency Trading” or simple exhortations to abandon the dollar and “Buy Gold.” The interesting thing to consider is that the people selling each of these products earn substantial fees and commissions when you choose to buy. What these “systems” are banking on is that their promises of fast, easy profits will lure you to send in your money.
This is not limited to infomercials either. How many people concentrated their 401k portfolios in Technology stocks during the 1990′s, in Energy and Financial stocks during the Real Estate boom, and in Gold now that the spot price has rapid escalated in response to continued government budget deficits. Each of these represents a “fad” that is generated by investor enthusiasm for quick profits… not for fundamentals, not for cash flow, but for the simple fact that they expect prices to continue rocketing up, just like they have rocketed up in the past.
A common phrase among financial planners is that “Trees don’t grow to the sky,” meaning that abnormally high rates of growth cannot continue indefinitely. It would be well for many people to remember this wisdom, since the allure of easy profits results in “Beer Goggles” for investors that come on in full force. When seeking to earn returns from investing, it is critical to understand that there is no such thing as a free lunch. All investments carry some form of risk:
Default Risk
Some product such as bonds carry a risk of default, where the issuer is no longer able to pay. Typically, when the default risk is higher, the interest yield also tends to be higher. This means that bond investors who are earning high yields are running a greater risk of losing their principal. Most government bond investors are primarily worried about guarding against default with the guaranteed principal value of treasuries.
Market Risk
Products like stocks, mutual funds, and commodities carry a risk that the market value will be lower when they are sold than why they were purchased. This risk is even more pronounced when the security does not pay any dividends, because the returns are totally concentrated in capital appreciation. Volatility of market prices represents one of the main risks for equity or commodity investors.
Inflation Risk
A large risk associated with many investment products is that their performance will either not keep pace with inflation or will have their returns significantly eroded by inflation. This risk factor is especially dangerous for bond investors, since the interest payments from bonds are fixed. Because of this, investors who anticipate that inflation will result from current government policy should seek investment vehicles that are more robust in defending against inflation than bonds.
Liquidity Risk
Some investments such as Real Estate produce favorable rates of return from cash flow and leveraged appreciation, but are very difficult to sell quickly without significantly discounting the price. This means that people investing in these types of assets should only do so with capital that will not be needed for a long period of time. Problems can arise very quickly if your are forced to sell a property and must discount the price lower than your loan balance in order to attract buyers. In this situation, leveraged gains can turn into leveraged losses very quickly.
In the end, it is critically important for each person to remove the “Beer Goggles” when they are choosing their investment strategy. Sticking to fundamentals and avoiding the urge to chase after investment fads or pursue quick profits with packaged systems. By ensuring that your investing activity revolves around creating fundamental value for paying customers with your capital, it will help to avoid chasing the elusive quick buck and keep you on the track to building long-term wealth.