1. No investment strategy.
From the outset, every investor should form an investment strategy that serves as a framework to guide future decisions. A well-planned strategy takes into account several important factors, including time horizon, tolerance for risk, amount of investable assets, and planned future contributions. What do you want to accomplish, and when do you need to accomplish it by?
2. Investing in individual stocks instead of in a diversified portfolio of securities.
Investing in an individual stock increases risk vs. investing in an already-diversified portfolio. Investors should maintain a broadly diversified portfolio incorporating different asset classes and investment styles. Failing to diversify leaves individuals vulnerable to fluctuations in a particular security or sector. Also, don’t confuse stock diversification with portfolio diversification. You may own multiple stocks but find, on closer examination, that they are invested in similar industries and even the same individual securities. There is no guarantee that a diversified portfolio will enhance over returns or outperform a non-diversified portfolio. Diversification does not assure a profit or protect against market losses.
3. Buying High & Selling Low
The fundamental principle of investing is buy low and sell high. So why do so many investors get that backwards? The main reason is “performance chasing,” Too many people invest in the asset class or asset type that did well last year or for the last couple of years, assuming that because it seems to have done well in the past it should do well in the future. That is absolutely a false assumption. The classic buy-high/sell-low investor profile is someone who has a long-term investment strategy, but doesn’t have the tenacity to stick with it. The flip side of the buy-high-sell-low mistake can be just as costly. Too many investors are reluctant to sell a stock until they recoup their losses. Their ego refuses to acknowledge a mistake of buying an investment at a high price. Smart investors realize that may never happen and cut their losses. Keep in mind not every investment will increase in value and that even professional investors have difficulty beating the S&P 500 index in a given year. It can be smart to have a stop-loss order on a stock. It’s far better to take the loss and redeploy the assets toward a more promising investment.
4. Unrealistic expectations
As we witnessed during the recent bubble, investors can periodically exhibit a lack of patience that leads to excessive risk-taking. It is important to take a long-term view of investing and not allow external factors cloud actions and cause you to make a sudden and significant change in strategy. Comparing the performance of your portfolio with relevant benchmark indexes can help an individual develop realistic expectations. According to Ibbotson Associates, the compound annual return on common stocks from 1926-2001 was 10.7% before taxes and inflation and 4.7% after taxes and inflation. Returns on long-term bonds over the same time period were 5.3% before taxes and inflation and 0.6% after taxes and inflation. Expecting returns of 20-25% annually will set an investor up for disappointment.
5. Emotion trumps rational judgment
People hate to lose more than they like to win. This fear of regret causes investors to hold on to losers too long and sell winners too early. Investors tend to hold on to losing investments hoping that they will come back, rather than taking advantage of tax breaks. The contrary is true with winning stocks. Fearing a downturn and wanting to lock in profits, investors will sell stocks too early and miss out on potential future gains.
6. Timing the market
Market timing isn’t something for the individual. The basic idea is to buy at a set price at the end of the day and then selling on the next trading day (assuming the price rises). For the individual investor, this practice seldom makes sense for two reasons: first, profits are eaten by fees; second, the gains are fractions of pennies, so few individual investors have the cash to make these transactions worthwhile. What to do instead: In short, don’t do it.
Waiting for the right time can ruin your results over a lifetime. Procrastination takes many forms. You don’t start saving for retirement until it’s nearly on top of you. You “know” you should review your investments but other things always seem more pressing. You think you’ll catch up later when the market is better, when you’re making more money, when you have more time. And there’s the irony, because the longer you wait, the less time you have. Every day you delay is a day of opportunity that you can never get back.
8. Trusting institutions
It can be a mistake to rely solely on a broker or a brokerage firm, an insurance agent or your banker to tell you what’s in your financial best interest. The same is often true of government agencies, but that’s an entirely different topic.
9. Requiring perfection in order to be satisfied
We’ve all known people whose attitude is that nothing is good enough for them. People who can’t stand to have anything but “the best” are rarely successful at investing. In fact, there will always be something that’s performing better than whatever you have. If you happen to have the one stock that outperforms everything else this month, you are practically guaranteed that some other one will be ahead of yours next month. Perfectionists often flit from one thing to the next, chasing elusive performance. But in real life, you get a premium for risk only if you stay the course. And if you demand perfect investments, you’ll never stay the course.
10. Accepting investment advice and referrals from amateurs
If you had a serious illness, I hope you’d consult a nurse or a doctor, not somebody on the street who had an opinion about what you should do. And I hope you would treat your life savings and your financial future with the same care as you would treat your health. Yet too many people make big financial decisions based on things they hear. “I heard this hot tip.” “I know somebody in this company.” “I’ve got an inside source about this new product.” “My broker is making me a ton of money.” The lure of the hot tip is all but irresistible to some investors eager to find a shortcut to wealth. Unfortunately, many investors have to learn the hard way that there are no reliable shortcuts.
11. Letting emotions – especially greed and fear – drive investment decisions
I think the two most powerful forces driving Wall Street trends are greed and fear. Think about these two emotions the next time you listen to a radio or TV commentator explain what’s happening in the stock market. You’ll hear fear and greed over and over. There’s fear of rising interest rates, fear of inflation, fear of falling profits. You name it, somebody’s afraid of it. Fear is why so many investors bail out of carefully planned investments when things look bleak – and since everybody seems to be selling at the same moment, prices are down. That, in turn, reduces profits or increases losses. Greed blinds investors, making them forget what they know. In late 1999 and early 2000, greed prompted many inexperienced investors – and some experienced ones too – to stuff their portfolios with high-flying technology stocks, which had just had a terrific year. In the spring of 2000, technology stocks, especially the most aggressive ones, plunged without warning, leaving many of these greedy investors wondering what had hit them. Investors obviously want to make money. But this legitimate desire turns into greed when it runs amok. Likewise, investors obviously should want to avoid losing their money. Yet when a healthy respect for bear markets leads to panic selling, caution becomes counterproductive.
12. Focusing on the wrong things
It’s generally agreed that asset allocation – the choice of which assets you invest in – accounts for a large majority investment returns. That leaves less than a small percent for choosing the best stocks. But most investors focus at least 95 percent of their attention on choosing funds and stocks. Their energy would usually be better spent on asset allocation. Some investors also focus on small parts of their portfolios instead of the entire package. They can become obsessed with some small investment that seems to stubbornly refuse to do its part. Occasionally, an enraged investor will overthrow an entire strategy because of what happens to some small component of it.
13. Needing proof before making a decision
The ultimate stalling tactic for those who aren’t ready to make an investment is to require one more piece of information or evidence. You can get evidence, but not proof. You can prove what happened in the past. But there’s no way to prove anything about the future except to wait until it happens. There are two track records for any investment. The first one just came to an end, and it includes all of history. It can tell you the range of returns and risks that are reasonable to expect. But it can’t tell you anything about the future. The second track record starts the moment you invest. It’s the only track record that matters to you, and it may or may not have any resemblance to the track record of history. The only thing you can be sure of about the future is that it won’t look just like the past. That’s why savvy investors diversify beyond what seems certain at any given moment. To be a successful, happy investor, you’ve got to somehow learn to live with the ambiguity of an uncertain future.