Working in the investment industry for the past eleven years has given me exposure to a myriad of investment strategies, ideas, methodologies and products. No wonder why investing for yourself, especially if you’re at the beginning stages, can seem like an overwhelming and daunting task! But I get to see other’s portfolios everyday. I get to see what works, what doesn’t work, and what is just plain old luck! So what works? Is it a certain amount of exposure to small-cap stocks, is it gold, or is it something more?
Actually, it is more about what you shouldn’t be doing versus what you’re most likely already doing right. Here are the 6 biggest investment mistakes to avoid.
All too often I see people investing in what’s hot! You know, that stock you found that has been performing really well over the past few years. Chasing returns and investing in only what is hot, you’re going to find yourself over exposed and under-diversified. Sounds like a bad dream but if you remember the dot com bubble and the more recent financial crisis, you know that everything seems fine until it isn’t. Like the dot come bubble, investors owned tech stocks and everything was growing, growing, growing until … POP!! The bubble burst.
Being diversified, in terms of your asset allocation (the mixture between major assets classes of stocks, bonds, and cash), is the number one contributor to your portfolio’s performance. Just over 90% to be more specific. The investments you select and market timing has far less to do with how well your portfolio does over the long run. Avoid under-diversification and start with a strong asset allocation.
Yes, this is a real thing that I see a lot of also! On the opposite side of the spectrum I see people who buy just about every offering in their 401(k) plan. When you have too many investments in your portfolio it’s a duplication of efforts. You may be holding several different stocks or funds with different strategies but there is usually a lot of overlap and you end up with just a very expensive and inefficient index fund. You should have just bought the index fund in the first place and saved yourself a lot of trouble (and those higher expense ratios)!
Again, referring back to a strong asset allocation and limiting your portfolio to around 7 – 12 funds (sometimes more or less depending on the size of your portfolio) can offer the diversification you need without so many little investments weighing you down!
“You” Are Your Biggest Threat
Ask me what the biggest risk to your portfolio is and I’m probably going to tell you that it’s yourself! I love researching topics in behavioral finance because it helps me understand why people act the way they do when it comes to investing; why people are so irrational. If you look back on some of my other posts, take a look at my favorite books on investing. One of the books I listed was The Intelligent Investor by Benjamin Graham (Warren Buffett’s teacher you guys)! If you’ve read it, you know that he says “the investor’s chief problem – and even his worst enemy – is likely to be himself.” The book is old but it still holds true today because human nature is hard to change.
- Overconfidence Over-confidence is just another way to say that people have lost all sense of risk! High returns are great but usually because you are being compensated by a higher level risk that you’re taking. If things seem to keep going up and up and up… remember they are just as likely to go down just as quickly.
- Speculation There is a big difference between speculating and investing in my opinion. Speculation means you’re putting money into an idea or business model that may turn out to have great potential. Being in from the beginning of a great idea would be my greatest dream but I’m not going to risk the majority of my retirement portfolio for what could be. If you speculate it should be a limited amount of your portfolio.
- Regret This is a common behavior seen when you’re invested in stock that turns sour. You were confident that your purchase had little downside potential and when you see that initial loss, you hang onto it because you’re confident that it will go back. Only it keeps going down and you have this regret that you cannot sell it until you’re even otherwise you’ll have a loss.
- Panic During the financial crisis in 2009 I vividly remember phone calls that went like this, “get me out at any cost before I lose everything!!” And while yes, their investments were losing value, the fact of the matter is that they still held those investments but those investments were just worth less due to the circumstances not necessarily due to the health of the company they were invested in. If they jumped out near the bottom (sold low), the questions then is when things get better, at what point do they get back in? So wait …, you sold low and now you’re buying high? Sounds crazy but this is exactly what I mean when I say people are irrational when it comes to investing.
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