Over the years I’ve been coaching clients about how to become better investors. One thing I’ve noticed is that there are some common mistakes that seem to come up repeatedly, across the full spectrum of clients I serve. Even when I point out these mistakes, and show clients how to avoid them, they continue to fall into the same behavior traps again and again. Here’s a list of the most common, and costly, mistakes that I’ve encountered over time.
1. No investment strategy. Every investor should take the time to write a simple investment strategy that serves as a framework to guide their decisions. A simple but clearly written strategy takes into account several important factors, including time horizon, capacity for risk taking, trading rules and checklists, and planned future contributions. Studies show clearly that investors who spend even a small amount of time on strategy and planning, get significantly better results than those who do no planning. Investors who regularly review and update their plans, get results that are three times as good, on average, as those who do no planning.
2. Ad-Hoc stock picking. Investing in individual stocks, without considering how they stocks fit into a balanced portfolio, increases risk versus investing in an already-diversified mutual fund or index fund. Investors should maintain a well-balanced portfolio incorporating different asset classes and investment styles. Failing to diversify leaves individuals vulnerable to fluctuations in a particular security or sector.
3. Buying high and selling low. It should be intuitive to all investors that the goal of every trade is to buy low and sell high. So why do average investors do the opposite so often? The main culprits are fear, and performance chasing. What I see happening repeatedly is, investors wait until the stock market has gone down so far that they simply can’t take the pain anymore. When they finally sell, most of the decline has already happened. That’s selling low. Buying high comes from the irresistible urge to jump into the market when prices have been going higher and higher, and their friends and associates are making lots of money. But by the time they get in, most of the gains have already taken place. That’s buying high.
4. Trading too frequently. The studies on this subject are clear: there is a direct correlation between trading activity and under-performance. The reasons are simple. The more you trade, the more it costs you. And costs are profit-killers. Active investors perform about half as well, on average, as passive investors do.
5. Unrealistic expectations. Over the long term, stocks produce an average return of 9% per year. But stories of doubling or tripling your money overnight by investing in the next hot internet stock are so common that many investors build that kind of thinking into their general expectations about investing. The result is that investors have to take unnecessary risk with their investments, in order to hit that home run. It’s better to shoot for 9% per year, and try to do a little better with careful planning and good discipline.
6. Neglect. In my experience, most people do not have a natural affinity for the investing game. It can be boring and tedious, so people naturally tend to put off the tasks that are necessary for good performance. They ignore their monthly statements, put off their annual portfolio review, and generally ignore the entire process. But investors who spend even a small amount of time – 15 minutes at the end of each quarter is sufficient – get rewarded with outcomes that are far superior to those who neglect their investments.
As a coach, I spend a considerable amount of time with clients – especially new clients – going over these common mistakes and coming up with novel and practical ways to deal with them. For example, I have each client write a list of trading rules and checklists, so that we can review their progress quarterly. I also help clients set up automatic alerts, so that they are forced to pay attention to their investments when certain market conditions are met. Working with a coach to set up a simple planning strategy will pay off handsomely in the long run.