The Top Mistakes made by Investors
In my dozen plus years of advising individuals and businesses I have found a number of common mistakes that have derailed even the best laid financial plans. I thought by sharing them I might be able to help others sidestep the pitfalls and the negative impact they can have on your portfolio and long-term financial plans.
1. Failing to establish a time horizon and investing accordingly –
If you have expenses that need to be financed in 3 years or less, you should not be investing the cash for them in the stock market or other risky investments. These monies should be carved out of your investment portfolio (the money earmarked for long-term investing) and invested appropriately in liquid assets such as money market funds or term-certain fixed income offerings. If the money is not going to be needed for 3 years or more, an investment plan should be established based upon specific a time horizon and risk tolerance for these funds.
2. Failing to thoroughly diversify your portfolio –
Many investors know about the concept of diversification and think that by owning different investments, they are diversified. Diversification of an investment portfolio makes good sense on an intuitive level. However, it was not until Harry Markowitz published his model of portfolio selection that this concept became a formalized part of sound investment practice and formed the basis of today's Modern Portfolio Theory. Beyond this basic concept of diversification, the key to Markowitz's prediction is the revelation that the risk of any investment can be reduced and / or performance increased by forming a portfolio of diverse and non-correlated assets. That is, it is important not just to seek a diversity of asset types, but also to seek assets that have low or near-zero correlations to one another. It's not about owning different investments; It's about owning different, non-correlated investments.
3. Letting potential tax implications rule your investment decisions –
Many investors delay selling an investment that has done well regardless of how good or bad the future looks for the holding. Their response is, "I will have to pay taxes if I sell." By not selling, they set themselves up for not having to pay taxes at all – usually because the investment starts on a decline and their concern switches from "having to pay taxes" to one of "hoping for a turnaround." Do not be afraid to take some profits off the table. While taxes are an invalid result of investing, I prefer to look at them as a positive sign as it indicates you are making money and your investment plan is working.
4. Buying a stock based upon a "hot tip " –
Too many investors listen to a friend's advice because he or she always seems to have the next "great" money making idea. They do not take the time to assess the idea personally and jump in because it's only a few thousand dollars that they are investing. Unfortunately this is not investing – it's gambling. If you want to gamble, go to Vegas and at least get free drinks, dinner, a show and a room for the risks you are taking. Any investment that is being considered for your portfolio should be thoroughly reviewed and have passed a comprehensive financial screening scrutiny.
5. Attempting to time the market –
Waiting an extra day, week, or month to try and buy at the "right price" just does not work. No one can predict the future. If they could they most likely would not be sharing this knowledge with you for free. Successful investors use time, patience and a disciplined approach to increase the likelihood of maximizing their investment returns – not trying to time the market. If you have done the research and the investment is sound and meets your criteria then buy it, regardless of timing.
6. Failing to regularly reevaluate your investments –
Over time all investment styles, strategies and types fall out of favor. So, like timing the market, it becomes virtual impossible to know what is going to be "hot" in the next bull market and what is not. For this reason it is always prudent to stay up-to-date on your investments to insure they are still the same investment that you originally purchased (segment drift and manager changes can be one reason they may have changed). If your investments consist solely of mutual funds then an annual review is a good place to start.
7. Basing investment decisions on emotion –
Maybe the stock market is going through a bad time because of a short-term geo-political or economic event. Stay calm and make an educated, well thought out decisions about what, if anything, to do. Assess whether the event will affect the economy long-term or if it's just a short-term blip. The best move is often no move at all. If it is a short term incident, many times the smart, prudent investor will make additional investments because the current decline provides them with an excellent buying opportunity. The key to successful investing is to have a disciplined strategy and to stick with it.
8. Cashing out gains and dividends rather than reinvesting –
Once you've realized gains or had dividends and dividends paid out, insure they are reinvested back into your portfolio. If you pull out your capital gains, dividends and interest, your money will not compound as quickly, thereby leaving you with a smaller chunk of change down the line. Letting your investments compound is one of the major tenets of successful investing.
9. Owning too much employer stock –
Many people get over-weighted in employer stock because of options and stock purchase plans made available in today's competitive compensation packages. While these are great supplements to their annual salary they can put an employee in a position of having too much money invested in their employer's stock. Additionally, it is quite common for people to invest in "what they know" and what do you know better than the company you work for? To compound the problem many people will add more employer stock to their 401k holdings and individual brokerage accounts. Not only does this create a diversification problem in their portfolio but it also subjects them to excessive single stock risk. A good rule of thumb to follow is to insure that no more than 5-10% of your entire investment portfolio is in any one single stock. If you find yourself in this situation the importance of creating a well thought out reduction strategy can not be overstated.
10. Following the herd –
The most successful of all investors are moving in the opposite direction of what everyone else is doing. They buy when most are selling and sell when everyone else is buying. By following this simple plan you can reserve your capital and potentially sidestep the next bubble (can anyone remember real estate, internet stocks, and technology growth funds?).
11. Not investing at all –
Somehow in today's society that Mocha Cappuccino Latte seess to take precedence over saving for the long-term. We are a society who wishes to satisfy the "here and now" rather than the securing our future. The important fact here is that those two are not mutually exclusive. In fact, BALANCE is the key in any long-term endeavor, but by always keeping an eye on the end goal you can make sure it is not out of mind while satiating the here and now.
12. Investing without a plan –
Investing without a plan and lacking the discipline to follow it is a sure way to lower your chances of success. The chances of obtaining any long term goal can be greatly enhanced by creating a strategy, following it and regularly reviewing it frequently enough so it reflects any changes that have taken place since implementation. Many investors start off with a small amount of money and start putting it to work without a plan. As time progresses they find that they have a mish-mash of investments in their portfolio with no clear strategy or direction. It's never too early to invest but it's even better to invest early with a plan.
13. Taking too little risk –
Some people do not want to take any risk and can not stand the volatility involved with risky investments. While it may seem like you are keeping your money safe and secure by not taking risk, it is more than likely you are not because of inflation. If your time horizon is greater than 5 years it is recommended that you have no less than 25-30% in growth investments (ie stocks) in your portfolio to ward off the effects of inflation. The actual percentage to own is dependent upon many factors including but not limited to age, time horizon before money is needed, current financial situation, etc. A good general rule of thumb to use as a starting point for the percentage of equity you may include in your portfolio is "120 – your age."