Inflation Compounds the Cost of These Investment Mistakes
Inflation is a silent rustler seldom identified by the plundered. Many things may trigger price inflation, such as a supply constraint or a sudden spike in demand, but one thing may be properly identified as inflation’s cause. Following the Covid lockdown, the Fed created so many arbitrary new dollars that, short of a severe economic depression, it will likely be a decade or more before price inflation (CPI) reverts to its desired 2% range. The FOMC’s recent upward revision for inflation estimates through 2025 support this thesis,¹ again proving entrenched inflation is not easily subdued. Persistent high inflation amplifies both the need to live by sound financial principles (discover Inflation-Taming Budget Strategies), but also the cost of investment mistakes. Avoid these three investing pitfalls as you strive to overcome the Fed’s inflation with successful investing:
The Anchoring Trap lulls investors into owning household names, like Kodak, Blockbuster, and J.C. Penney, based on former glory, even as they are displaced by new competitors. Occasionally referred to as value traps, these high dividend blue chips are in reality dinosaurs worthy of abandonment. Reinvesting a huge dividend doesn’t help when the share price is going to zero! The tires on every “Forever Stock” must be periodically kicked to affirm present industry relevance and the sustainability of future earnings. This is especially needful during times of rapid technological advancement, as Amazon proved in the last decade, and may prove again on the other side of things in the coming decade. Assume nothing, and allow only present facts to influence your investment decisions. Do your homework.
The Pseudo-Certainty Trap consists of two investment mistakes. The first involves reducing portfolio risk during a period of positive performance. It’s like a rabbit which slows down when it gets ahead of the turtle, but loses the race taking an unplanned nap. Allow stop-loss orders to instruct your selling and risk reduction, not your wayward emotions. The second is more injurious, which involves adding risk by increasing portfolio risk during a period of negative performance. This mishap constitutes attempting to catch a falling Kbar with your bare hands; the injury is generally bloody! The trend is your friend. Wait for a confirmed uptrend to increase investment risk.
The Sunk Cost Trap is born from the illogical (though nearly universal) assumption that a company is more valuable because we own it, grows into an obstinate refusal to sell regardless of the evidence we are wrong, and fully matures when we commit additional capital to a sinking ship. This mistake devastates portfolio returns, but is easily avoided by consistently establishing an exit plan for all non-forever holdings, and sticking to it.²
Think about it, and blessings on your investing efforts! Shaun
“The way of a fool is right in his own eyes, but a wise man listens to advice.” ~Proverbs 12:15
“In the abundance of counselors there is victory.” ~Proverbs 24:6
1 AIER, “FOMC Ratches Up Inflation Projection”, January 2, 2023 2 Daily Wealth, “Make Investing Easier by Avoiding These Three Traps”, by David ‘Doc’ Eifrig, December 30, 2022
The opinions voiced in this material are general, are not intended to provide specific recommendations, and do not necessarily reflect the views of LPL Financial. The economic forecasts set forth in this commentary may not develop as predicted.
All investing involves risk including the possible loss of principle. No strategy assures success or protects against loss.
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