How to Avoid the Ten Most Common Investment Mistakes … Plus a Bonus
It’s pretty well accepted that there are two key things that drive the markets and the fortunes of millions: Fear and Greed.
Despite all the financial analysis, sophisticated computer models, talking heads and academic research, it seems that the most prevalent drivers are these two human emotions. On a daily basis this is what it almost always boils down to regardless of the headlines or explanations of the people in the know.
Fear can drive an investor to vote against his own financial interests by selling at the “wrong” time or by avoiding opportunities. Greed can lead to overconfidence and hubris in one’s own abilities and then taking on avoidable risks.
What’s an investor to do?
Well, the first thing that needs to be done in order to fix a problem is first admit there is a problem. Then you can identify the common mistakes. Armed with this information, an investor can then be better prepared to control his own demons and the self-destructive actions that they can foster.
Here’s a summary of the ten – I mean eleven – biggest mistakes that investors of nearly every age, risk profile, experience level, education and achievement level are prone to make. It’s not an exhaustive list but does provide the highlights of the problems. In this series, I’ll address each mistake in more detail.
Mistake #1: Treating Investments Like a Part-Time Job — Not a Business
Often times those who are successful in other aspects of their lives tend to believe that they have the skills to manage all of their financial affairs despite the time demanded of them in their other business pursuits.
A successful professional may command a high current salary and may even spend up to or beyond their earning capacity. The truth is that that same professional is unaware of how much in assets may be needed to maintain their preferred lifestyle now or in retirement.
This is why most investors fail. They fail to have a “business plan” in place to help them manage their goals, income and future wealth in a meaningful, quantifiable way.
Mistake #2: Not Having an Asset Allocation Strategy
Too often investors end up with a collection of investments picked up along the way without any real rhyme or reason. Investors tend to focus on the tips gleaned from financial magazines or news shows but ignore how, if at all, a particular recommended stock fits into their personal plan.
Mistake #3: Trying to Time the Market
It’s certainly true that if you buy low and sell high, you’ll create wealth for yourself. But most professional money managers much less individual investors don’t exhibit the skill to successfully and repeatedly accomplish this.
Mistake #4: Letting Emotions Drive Investment Decisions
Money is a tangible way to keep score in our society. It also is a fragile vessel of human emotion where all of our fears and past experiences tend to be stored. And too often subconscious and irrational emotions end up driving the investment decision process.
Mistake #5: Ignoring The Biggest Risk of All
Ask most investors what their definition of risk is and it will be something like “loss of principal” when in reality the greatest risk to investors is more likely running out of money before meeting your final check out. Time can be the greatest ally and the greatest enemy of an investor. With longer potential lifespans and higher lifestyle needs, there is the risk that you’ll not accumulate enough to properly fund your needs.
Mistake #6: Expecting Any Manager’s Investment Approach to Work ALL the Time
The market is not like a well-oiled machine that always moves in one direction. Investment approaches are dynamic, just like people and their emotions. Over short periods of time, styles may drive performance. And like a football or baseball coach, you need to realize that even good players need to rest or be benched for a while.
Mistake #7: Hiring Managers Solely By The Numbers
Most investors pour over the performance records of mutual funds and money managers. They focus on the star ratings in Morningstar or the rankings in a magazine. And despite the warning that “past performance is no guarantee of future results” most investors end up chasing what was hot. Ultimately, they are disappointed and without any conviction to a style or approach they either dump their holdings or add another without any clear plan.
Mistake #8: Getting Caught Up in the Relative Performance Game
Investors can be easily forgiven for this one because the media focuses so much on the daily ups and downs of a couple of major indexes. What matters most is not how well you’re doing compared to an index but how well you are progressing toward your own particular goals.
Mistake #9: Not Knowing When to Fire a Manager
Too often investors exhibit the same sort of rules that apply to physics. Newton showed that something in motion tends to stay in motion and something at rest tends to stay at rest barring some outside force changing the status quo. In investing, investors tend to hold on to managers that should be replaced because of their inertia and because there is no real process for review.
Mistake #10: Not Having an Investment & Planning Professional
For busy, successful investors, how are they going to really have the time, skill and inclination to properly develop an investment plan, create an asset allocation, choose investments, rebalance regularly, monitor managers and find replacements when needed? Managing wealth for the long haul is like any other business and it requires having the help of a professional team. Those who typically work with a planning professional have more wealth and peace of mind.
Did I say ten? Well, here’s my last one:
Mistake #11: Not Understanding the Cost and Value Trade-off When Investing
Too often investors have no real idea of what their investment approach is costing them. Money held in a 401(k) is managed for free, isn’t it? The fixed or variable annuity bought at the bank has no cost, right? The actively managed mutual funds save you money, don’t they? Most investors believe that they are saving money when they try to manage their financial plan and their investments on their own simply because they don’t want to pay a fee to a professional for help. Focusing on near-term costs and ignoring the value that a professional may bring to your bottom line is short-sighted and potentially shot-changing you and your wealth.