At a recent party, a friend told me he had an investment idea he wanted to run by me.
“I’ve got a substantial sum of cash that I need for a real estate closing in six months,” he explained.
“The bank pays nothing. Bonds yield next to nothing. So I’m going to park the money in AT&T (NYSE: T) for six months. Even if the stock goes nowhere, I’ll still earn a dividend yield of 8.3%. What do you think?”
I told him I thought it was a bad idea.
He seemed stunned. “Why?” he asked. “You don’t think the dividend is secure?”
The dividend may or may not be secure. (Most 8% dividends aren’t.) But that’s a secondary issue.
(Although – let’s be real – very few stocks rally into the announcement of a dividend cut.)
The more pressing issue is that he needs this money in six months and the stock might be worth a lot less then.
“Stodgy ol’ AT&T?” he asked. “You think it’s too risky? Heck, even if it goes down 4%, I’d still be better off than if I’d put the money in the bank!”
I asked him if the stock going down 4% was the worst he could imagine.
“A widows-and-orphans stock like AT&T shouldn’t drop more than that,” he insisted.
His imagination was limiting him. But so was his knowledge of history.
AT&T is down 26% from the high it hit six months ago. (Imagine showing up at a real estate closing with only three-quarters of what you need.) The share price is 20 points lower today than it was 20 years ago.
He seemed astounded by this news. And insisted that I had just saved him a bundle.
Maybe. I might also have cost him a bundle.
After all, AT&T could rally significantly from here over the next six months.
But that’s the whole point. No one knows.
Why risk not being able to close on a house because the stock market – or one particular stock in that market – is down?
Rolling the dice with money you know you’ll need in a few months is not a smart move.
After all, things don’t always unfold the way we imagine.
Yet in my 37 years in this business – first as a money manager and later as an investment analyst – I’ve learned that people have a tendency to imagine a certain outcome and then invest as if it’s a near certainty.
This applies to people who are too bearish as well as those who are too bullish.
The bearish ones sit on the sidelines, imagine stocks going much lower and envision themselves buying everything at a steep discount.
Indeed, my colleague Mark Skousen just told me about a friend who got out of the market during the financial crisis 13 years ago – and is still sitting on the sidelines.
He’s waiting for the Dow to get back under 7,000, apparently.
Investors enjoying a rip-roaring bull market, on the other hand, start to imagine that stocks will just keep rising forever.
But as we saw in last year’s first quarter, bear markets show up without prior announcement.
They generally last a lot longer than that one, too.
That’s okay for investors who realize that bull and bear markets are just a fact of life.
They’re not only inevitable. They’re a great source of opportunities.
But millions of new investors have no bear market experience.
Many will learn that the reality is different from their expectations.
It’s a shock to see real money suddenly evaporate, even if temporarily.
Buying the dip gets quite a bit harder when the dip turns into a free fall.
There is fear… anxiety… shame… regret. Plus, bargains galore that almost no one is interested in.
There’s a big difference between imagining a bear market… and living through one.
Experienced investors know what I mean.
Newer investors? They can’t imagine.
Click here to watch Alex’s latest video update.