Where's the exit? Have a plan before you invest.

• Author: Nelson, Gordon L.
• Position: Money Talk

We've all heard the airline safety routine about what happens in case of a cabin pressure change--that our seat cushions can act as floatation devices and that we should know where the closest exit is located, "keeping in mind that the closest exit may be in back of you."

Observing most airline passengers during the presentation, it appears they feel so familiar with where the exits are that there is no concern--the attitude is "just take off and get me where I want to go." But in the case of a real emergency, I wonder how many people really know what to do.

It's too bad everyone isn't given a similar safety presentation before they put money into an investment. Some investors seem to believe that you can just buy something, wait for it to go up and all will be well--"just take off and get me there."

But what if you're wrong and it doesn't work out? Do you have an exit plan?

In my experience, far too few investors ask these important questions before making an investment. While many people profess to have a great idea of what to buy, very few seem to have any kind of a plan for when or how to sell. Very few seem concerned enough about knowing where the exit is.

But investing without a predefined exit strategy is a recipe for disaster.

If you ask people why they don't have an exit plan, a common answer is "I'm diversified." It's true that being diversified is better than not being diversified. However, diversification is a tool to help reduce volatility, but it sometimes does a very poor job of protecting your portfolio from a significant drawdown when a market tail event occurs. Nor can it protect against loss. The price behavior of many investments is tied more closely together when real panic hits, like in it did 2008.

Some generally accepted portfolio construction methodologies failed to account for both worst-case scenarios and potential illiquidity--both of which were experienced in the crises of 2008. To move ahead now with the idea that things are back to business-as-usual is dangerous.

A New World

Any rational investment plan has to start with one simple question: What if I'm wrong? The investment world has changed, and if you didn't have a well-defined and pre-determined exit strategy for your investments before, it's time to get one or find an advisor who can help you get one now.

The challenges that this new investment world presents to both individuals in retirement and those who are trying to accumulate enough to retire on...