Investors don’t ask the question of why or just say no very often, but they should.

I recently was thinking about some investment idea pitched on television, wondering if it might be a good idea.

Obviously, the people on TV money shows must be real geniuses, right? So, it must be a good idea, right?

But then I asked myself a simple question: WHY?

Why would this idea really make sense for me? What purpose would it serve in my plans? And, as Warren Buffett has noted, he has seen thousands of ideas over the years and only said YES a few times. 

Most investment pitches are focused on higher returns — making more on your money.

But Rule No. 1 for investing ought to be that there is no free lunch, that higher potential return involves higher potential risk.

That’s a fundamental concept of economics, and the road is strewn with poor investors who failed to pay attention to it.

Over my many years as a financial adviser, I witnessed the reality of this important concept. Let me share some true stories that you might find informative as you navigate the seas of investing.

High Returns

Let me start with a story dating back more than 25 years. We were out for an enjoyable dinner with very good friends I’ll call “Mary” and “Bob,” who was our family doctor.

They were in their mid-50s and enjoyed a nice family, good income, solid finances,and a desire to retire in five years or so.

“Bob” asked some questions about investing, and per my usual advisory style, I asked him what his goals were for investing.

He quickly answered that he wanted “a high return.” I responded simply by asking “WHY”?  My response really surprised him, and he replied that “everyone wants a high return,” and the late 1990s stock market run-up had clearly gotten his attention.

I simply noted that while some folks hoped for high returns, many were uncomfortable with the high risk that comes with more aggressive investing. Instead, they found safety and peace of mind more important.

I asked “Bob” what would happen if seeking for high returns backfired and he had sizable losses at this stage in life — with only a few years left to recover before retiring.

This brief conversation — and asking WHY — sparked serious planning discussions leading to a more moderate investment strategy.

The dot.com bust that followed a year or two later made “Bob” thankful for being asked WHY. 

I had other similar conversations over the years, often to help clients avoid trying to jump on a runaway train during wild market upturns.

Buying the Dips

One of my younger business partners had success trading a small Seattle pharma company.  He seemed to have a knack for buying it low, riding it up, and selling high. So, I decided to try to do the same.

I made a modest purchase on what seemed like a dip and subsequently watched it continue further down.

If it wasn’t in my Roth IRA, I would have sold it and taken the tax loss, but at this point I’ve decided to hang on with the hope that the company might actually discover a new drug.

Moral of the story: Sometime dips are just the beginning of a long ride down. I should have asked myself WHY — and just said NO.

Gold Rush

Gold is on fire, up more than 23% year to date and up about 37% for one year (as of July 11).

It can be tempting to jump on the bandwagon, especially with all the current economic and market uncertainty.

But a longer look tells a different story. 45 years ago, gold hit a high of $2,040 per ounce.  Keep in mind that gold doesn’t deliver any current income — just price change — which my calculations show just a 2.5% annual return since 1980.

A century ago, gold was selling at about $368 per ounce — so going up to $3,228 today sounds amazing.

But that represents just a 2.2% annual return for 100 years. By contrast, the S&P 500 has enjoyed an average annual return of just over 10% since 1925.

Moral: All that glitters is not gold. Ask WHY you want to buy gold.

Tax Credits

The Low-Income Housing Tax Credit was enacted as part of the Tax Reform Act of 1986, and was intended to encourage more housing to help low-income citizens.

But, as often is the case, no good deed goes unpunished. An entire industry sprang up with developers eager to build and investors looking for big tax savings — not really focused on helping meet real housing needs.

I watched as promoters packaged projects into partnerships that could be sold in “bite-sized amounts” to small investors. Sales representatives were lured by high commissions, and selling the “sizzle” of big tax benefits to investors was easy.

Evidently, my suspicious nature is hard-wired, and I almost immediately thought these were lousy investments.

The developers made money, the promoters made money, and the sales people made money — after which little was left for investors.

I learned an important lesson about asking questions, and to avoid letting “the tax-tail wag the investment dog.”

dot.com Era

The dot.com era is now about 30 years behind us, but what a ride it was. While there are certainly a few very successful survivors (including Amazon, Microsoft and eBay), many startups had unsustainable business models.

Often they were just plain goofy ideas. Just come up with some idea, add dot-com to the name, and voila, investors lined up to get in.

These startups rented lots of office space and hired staff at high salaries but failed to generate sufficient revenue to cover big costs. Once they blew through the cash from the initial public offerings, they ran out of money and went out of business.

Notable failures included Webvan, a $6 billion grocery delivery startup that went bankrupt, and eToys.com, which had a market valuation in 1997 of more than $8 billion (without ever making a profit) and whose assets were ultimately sold off for $5 million in 2001.

Stock prices of these startups rose incredibly fast, and mutual funds focused on these kinds of companies were hot sellers.

The Van Wagoner Emerging Growth Fund gained 291% in 1999 (WOW) but then saw more than a 45% average annual drop for the following three years.

Many of the dot-com companies failed to ever make money and simply disappeared, leaving investors with massive losses.

Asking WHY invest in a company that you don’t understand and has never made a profit seems wise. And saying a big NO to so many would have saved you a lot of grief.

Margin Calls

Buying stocks on margin can be fun when markets are soaring. You can borrow money from your broker to buy stocks.

Schwab provides a simple example. Let’s say you want to buy 1,000 shares of a marginable stock currently trading at $50 per share.

If you bought with cash, you’d need $50,000. But you could buy the $50,000 in shares through a margin account for $25,000.

If the stock rises from $50 to $55 per share and you sold it, you’d make $5,000, a 20% return since you only had to use $25,000 of your own cash.

But margin cuts both ways. If the stock dropped to $45 per share, you’d lose $5,000, or 20%. And in either case, you pay interest on the margin loan.

Things get really dicey if the stock price fell further. If the value of your 1,000 shares drops below $35,000, you’ll get a margin call requiring you to pony up cash (typically within two to five days).

Margin accounts can be great when markets soar, but terrifying if stock prices fall badly.  Asking yourself WHY take the risk? seems smart.

Successful investing involves being strategic, thoughtful and patient. Every “deal” may not be such a great deal after all.

Having a long-range plan, carefully evaluating options to make sure they fit into your plan, and letting time produce the amazing benefits of compound interest can really pay off.