Ask Jake: What are some common mistakes that investors make?
Whether you’re new to investing or have been investing for years, it seems like there’s always something new to learn. As regulations change, markets move, and time goes by, investors frequently face new challenges.
While there’s no way to ensure that you’re never going to make an investing mistake, there are some ways to become a better investor. Today, we’re talking to Jake Sturgill to learn more about some common mistakes that investors make – and savvy investors can avoid these pitfalls.
Here are some common investor mistakes, according to Jake:
Many financial experts claim that diversification is one of the most important things to consider when investing. But sometimes, too much of a good thing is simply too much.
Over-diversification is, in some ways, owning nothing by owning everything. This mistake manifests itself when you have a core portfolio, then purchase something else… and something else… All of a sudden you own a bunch of stuff that more resembles a nicely curated collection of financial trinkets as opposed to a healthy investment portfolio.
The flip side to over-diversification is, of course, under-diversification. This is the impulse to keep narrowing your portfolio down to “what’s working”. In theory, choosing what works is a good idea, but as the markets approach significant tops, the basket of “what’s working” typically shrinks to just one or two ideas. So, under diversification is essentially narrowing a portfolio to one idea — this is a big mistake.
Here are some examples of under-diversification:
- You have just one stock — maybe you inherited it or worked for a company with a stock option for 30 years. You can get wealthy by under-diversifying in this way, but you cannot stay wealthy over the long-term.
- You chase hot managers or sectors — hot investments can be thrilling, but they can present significant volatility and risk. While some investors can stand to dedicate a portion of their investing “pie” to these investments, they aren’t for everyone.
- Euphoria or Overconfidence
In summary, euphoria or overconfidence is really just greed. When you get caught up in euphoria, you lose sense of the principal risk. When you forget about risk to principal, then you instead worry about being outperformed.
It’s not uncommon for euphoria or overconfidence to pair with Mistake 2: under-diversification, especially if you’re chasing hot markets. If you’re prone to investor overconfidence, it’s imperative to align yourself with an advisor who knows when to anchor you to a more sound investing strategy.
And of course, the opposite of overconfidence is panic. Both stem from an emotional investing attitude and can be detrimental to your portfolio’s performance.
Panic is the failure of faith in the face of the apocalypse du jour. Just as it’s wise to avoid fear-driven panic selling during extremely volatile periods in financial markets, it’s also wise to avoid greed-driven euphoric buying during extremely bullish periods — again, it all boils down to avoiding mixing emotions with investments!
Panic can be sneaky and almost always rationalizes itself. You might think: I have to get out until we see who wins the election, I need to get past depression, wait for this deficit to get under control, for inflation to get under control, for unemployment comes down.
If you look hard enough for a reason to panic, you’ll find one. For many investors, the source of their panic is driven by current events.
Bottom line? It is perfectly normal and okay to feel fear about current events/political climate/market performance but it is generally not advisable to act on the fear.
Speculating when you think you’re still investing
When you’re investing, at some point you’ll probably hear the siren song of a new era and be tempted to chase hot price trends instead of evaluating investments on their intrinsic values.
Remember, an investment is an identification of value. Speculation is a bet on the continuation of a price trend. Speculatory behavior is not a suitable strategy for most people.
This ties into the whole euphoria/under-diversification class of mistakes — you chase what’s hot, what’s working right now. Performance chasing can be thrilling, but again, it’s probably not going to play out well next quarter, next year, next decade.
Some recent examples of hot trends include: tech stocks in 1999, real estate in 2005, oil in 2008, gold in 2010. Investors look to recent patterns: typically investments that have done well for the past 5 or so years, and assume that this record is strong enough to bring them success over time. Speculating on hot trends always seems intelligent at the moment, but can be costly in the long-run.
Letting your cost basis dictate your investment decisions
One common mistake you might make is asking your investments to behave differently because of what you paid for them. After all, you put in the investment; now you want the payout. This kind of thinking can cloud your judgement and make it difficult to know when to cash in or offload under-performing investments.
Some investors make great fortunes by owning one spectacularly successful stock, but end up giving it all back by refusing cash in and to pay capital gains taxes on the earnings. In reality, capital gains taxes are lower than ordinary income taxes, but some investors lose sight of the big picture when they view the tax as a loss on their big gain.
Of course, there’s always the temptation to hang onto a poorly performing investment for too long because of the mentality that you need to stick it out long enough to earn back what you put into it. Maybe you’ll earn it back, maybe you won’t. In many cases, your money would do better elsewhere.
Want to avoid these investor mistakes?
It’s hard to avoid investor mistakes, since most of avoiding investor mistakes simply means keeping a clear head and considering your investments in purely objective terms. Removing emotions from money is a challenge!
Instead of trying to check yourself and risking the primary investor mistakes, look for a financial advisor who can help you to stay on track and act as a voice of reason when you are uncertain.
If you’re ready to approach your investing with a new perspective, contact Jake today to identify the investor mistakes you’re most likely to make and how to avoid them in the future!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.