Investing is an inherently human activity. It’s our humanity that leads to differences in investment performance. We all have access to the same markets, to the same information, to the same opportunities — yet we sometimes make mistakes.
Whether our investments do well or our investments do poorly, the unique factor in our investment performance is that it’s ours. We’re the difference. That’s actually good news. The difference is under our control. The markets certainly aren’t. But how we fare relative to other investors is a function of our actions. We determine our own outcomes.
To the extent that our investment performance is suboptimal, we can fix that. The primary reasons people fail to achieve average or above-average returns is that we, as humans, make errors. And we, as humans, can also change. Avoiding the top investing mistakes should put you at least on equal footing with the masses. And since so many make these mistakes it could put you a tad ahead. We can learn from not only our mistakes, but from the mistakes of others.
1. Being Overly Hands-On
Being overly hands-on hurts investment performance. One way is through excessive trading. An investment that was a good choice a week ago or a month ago should still be a good choice today. There are rare exceptions, but they are rare. That’s why we call them rare exceptions.
If you find yourself jumping from investment to investment in search of the next great thing, you’re not going to find it.
You will, however, incur a lot of unnecessary trading costs.
Build and Personalize Your Investing Portfolio — Get Your Stock Advisor Offer >>
Being overly hands-on can also result from reacting to the news. There’s a finite amount of information creating an unlimited amount of news. The only way you can get so much news from so little information is to make it look like more than it is. Even financial media should be considered suspect.
All other media should be ignored from an investment standpoint. Markets react to news because people run out and make ill-informed decisions based on some snippet from a news source that probably doesn’t understand markets and certainly doesn’t understand the individual’s financial situation. Don’t be that person.
Being overly hands-on results in too much trading. Investing is a long-term process. Short-term reacting kills long-term results. A periodic checkup and rebalancing is important. You can respond to changes in the economy and the world. A response is a well-thought-out strategy-based adjustment. Responses are acceptable, and only rarely necessary. A reaction is an automatic or emotional response to some stimuli. Respond when appropriate. Never react.
2. Focusing on Returns
Returns are the result of implementing a strategy designed to achieve an objective across a period of time. They’re a partial indication of how you’ve performed, but need to be considered in the context of additional information. The focus needs to be on making the best decisions in the present to achieve the outcome you want at some time in the future. Short-term returns and short-term fluctuations in returns don’t matter. Poor investment performance in the short-term can actually improve your long-term results if you’re adding to your investments.
Long-term portfolios are equity-based, like a home. You wouldn’t buy a home to live somewhere for six months. You shouldn’t invest in equities for a goal that’s six months away.
But if you own a home you don’t worry about its value every day. You should be confident that you will gain in value across a long period of time. Or else you may need to respond to that situation and evaluate it.
There are two ways to effectively deal with short term returns. Some great investors ignore them completely; they check on their portfolios only at specific intervals or when some catalyst necessitates checking in. Others monitor their short-term returns and emotionally detach from the fluctuations; they are aware of their returns but don’t make decisions based on them.
Both methods are effective. The don’t-look method is a lot easier.
Build Your Personalized Portfolio in Minutes — Start Investing >>
3. Following the Crowd
The crowd is ill-informed. The crowd buys what some media indicated would be the next hot thing. They fuel your emotions. You become sure that an investment will move strongly in a positive direction in a short period of time. So you jump in. You find out that feeling turned out to be the pain of loss. Funny how it felt so positive!
Crowds are not good indicators of future performance. That should be a required disclosure. But now you know.
4. Waiting to Invest/Under-Investing
There’s never a wrong time to start, but there are wrong things to invest in. This is what causes the confusion. Here’s the clarification: Buying into a bubble isn’t investing. It doesn’t matter which bubble burst; you shouldn’t have been in bubbles. That’s speculating, not investing. You can do it for fun, but it’s not how you achieve long-term goals.
You can always begin by investing systematically into quality investments. That’s what has proven time and time again to create wealth.
You can’t score points in the game when your butt’s on the bench. Get in the game.
5. Failure to Align Investments and Goals
Investing is a strategy-based method of achieving your long-term financial goals. Investing that’s not geared toward goals is like trying to score when you don’t know what game’s being played. Achievement of your long-term financial goals is the ultimate indicator of your investment performance. If you establish a strategy to achieve a specific long-term financial goal and design an investment plan appropriate for that goal, then monitor and make adjustments as appropriate, you will either achieve the goal or come as close as reasonably possible.
Build and Personalize Your Investing Portfolio — Get Your Stock Advisor Offer >>
But you’ve got to have a target. The goal drives the strategy, which drives the investment selection. Horse before cart. Cart without horse isn’t a long-term solution. Wasn’t back in the day, isn’t now.
6. Having Expectations
There are only two kinds of expectations that are a problem: your expectations and other people’s expectations.
We humans are an interesting lot. We tend to struggle in the present and yet still have preconceived notions of what the future should be. That’s what an expectation is — a preconceived notion of the future.
We can reasonably expect some general things about the future. We can expect markets to trend upward across time, some very general and basic things.
We can make assumptions, but need to know their limitations.
The future will be different than we expect and some of those differences will be material. That’s ok. Not that we have a choice for it to be otherwise.
Other people’s expectations are also problematic. We buy into other people’s expectations of what a good or reasonable rate of return is, other people’s expectations of what the economy will do, other people’s expectations of what we should invest in and how much we should invest.
But they’re not us. They don’t have our lives; they have theirs. What’s good for them may or may not be good for them. That’s their business. But their expectations aren’t our business and shouldn’t influence our decisions.
7. Misunderstanding Risk and Diversification
There’s a lot of misunderstanding in the investing world. Unfortunately, people often don’t understand their investments. And if they don’t understand their investments, they don’t understand the risks.
Diversification is a risk-management tool. It is not a way to maximize returns. You give up potential returns for stability or a higher degree of predictability.
Higher potential returns also have a greater chance of not coming true. They’re potential until they’re history.
To improve the probability of achieving our long-term goals, we should invest in the portfolio most likely to get us there. There are portfolios that will undoubtedly produce higher returns — but at a risk. And if the objective is to achieve the goal, then achieving the goal is the limiting factor in accepting risk.
Diversification doesn’t eliminate risk. It doesn’t guarantee you’ll achieve your objectives.
What diversification does is provides a mechanism to remove you emotionally from the equation. Seriously, that’s its greatest contribution to any portfolio.
Build Your Personalized Portfolio in Minutes — Start Investing >>
We diversify against some benchmark, either via asset allocation, or some other portfolio modeling where we determine an ideal portfolio composition to achieve our long-term objective. Then we periodically rebalance our portfolio to keep it in line with our target portfolio.
And here’s how we rebalance. We sell some of the investments that have been doing really well and buy more of the ones that have been doing the worst.
Seriously. That’s what we do. That’s what we should do. That’s what we need to do because it works.
And that’s why we have to be removed emotionally from the process. Because we don’t want to sell what’s working and buy what’s not working. Even though that works.
A Simple Process: Understanding the Game and Avoiding the Top Investing Mistakes
The process should be remarkably simple and stress-free. Really.
You need clarity around your goals. And you need numbers for your goals. They are, after all, financial goals. A good advisor can help with the numbers. And there are a many calculators out there on the web. If you aren’t friendly with math, you have lots of places to get help.
Where you are, where you want to be, and what you have to work with determine what your investments need to do. It’s no more complicated than that. It’s just math.
Knowing what you need your investments to do determines what you need to invest in asset class-wise, not individual investment selection-wise. Asset allocation or another portfolio modeling tool can break it down for you. Here you are diversifying among asset class to balance your risk with your return objective as determined by your needs.
Build and Personalize Your Investing Portfolio — Get Your Stock Advisor Offer >>
You’ll also need to diversify within asset classes without getting overly crazy about it. The asset classes carry your portfolio. If you chose main-stream, low-fee investments, your asset classes will do the work, and in the long run individual investment selection will be a lesser factor.
The key is staying true to the process. Define your goals. Develop a strategy to achieve the goals. Implement the strategy. Monitor and adjust. Don’t do those common investing mistakes we talked about earlier. They’ll just derail you from the nice simple and stress-free process that investing to achieve long-term goals should be.
