Not long ago, I read the results of a survey that the Chartered Financial Analysts Institute had sent to its members. The organization was interested in learning about the most common mistakes made by individual investors. What they learned wasn’t all that surprising but should be reviewed by anyone with an investment account. After a year like we’ve had in 2017, where markets only seem to go up, it’s especially important. Like the rising tide that lifts all boats, a rising market can cover up mistakes that can hurt when we finally see a return to more normal markets.
Here are the top 12 mistakes listed in the results of their survey. Let’s see how many of these you might be making.
No strategy. This is like going on a trip without planning where you are going. Sometimes it works out and you'll have a good experience, but most of the time you'll end up getting lost. Getting lost with your investments is not a good thing. You should consider developing an Investment Policy Statement (IPS) that considers your time horizon, risk tolerance, goals, liquidity, and cash flow needs. An IPS is like a GPS for your investments.
Buying individual stocks instead of creating a diversified portfolio. Investing in individual stocks is riskier than owning a diversified mutual fund. There are thousands of individual stocks that you can invest in—and that's just in the U.S. How do you pick the right ones? A better plan is to own a diversified portfolio covering the major asset classes.
Investing in stocks instead of companies. Too often, investors buy a stock without understanding the fundamental outlook of the company. Is the company profitable? Is management solid? Is there a solid and viable business plan? Buying a stock in a company just because you like their product or service is a sure way to lose money.
Buying high. This all-too-common mistake is caused by "chasing performance"—buying an investment because it has done well recently. There are lots of examples of this one: The dot-com mania at the end of 1999 and the housing market in 2004 and 2005 are a couple of good examples. Too often, people see an investment move higher (think Bitcoin) and buy because they are afraid of missing the boat—usually just before the boat sinks.
Selling low. This can be just as costly as buying high. Usually this occurs when we see a drop in the value of an investment. Fear of “losing it all” kicks in and results in selling the investment just before it starts to recover.
Rapid turnover of investments. Trading too often reinforces a focus on short-term performance over long-term fundamentals. It also cuts into returns by increasing transaction costs and, possibly, tax consequences.
Acting on tips. You might think you have an inside scoop because of something you saw on CNBC, read in a financial magazine, or heard from a friend. Do you really think you have an edge over the professional investors? If you've heard it, so have a lot of others.
Paying too much in fees and commissions. Unfortunately, most people don’t know what investment-related expenses they are paying. And the big Wall Street firms don’t make it easy to find out. You need to become fully informed on transaction costs, management fees, and other costs that may apply to your investments.
Too much focus on tax avoidance. While taxes should always be a consideration in an investment decision, they shouldn’t be the main driver. Holding on to assets simply to avoid taxes can lead to poor investing decisions.
Unrealistic expectations. Investors who are willing to take risks to achieve above-average returns are usually the ones who will be most disappointed by a sudden market rout. Instead, stay focused on the long term and try to set reasonable return expectations.
Neglect. Many investors take a head-in-the-sand approach when it comes to their investments. They don’t understand all the intricacies of managing a portfolio, so they don’t try. It’s important to know what you don't know—and if you don't know, hire a professional. And if you think it's too expensive to hire a professional, wait until you put your future in the hands of an amateur!
Not understanding risk tolerance. In the investment world, it’s all about risk and reward. The more risk you have in your portfolio, the greater the potential return—and loss. Know your limits. Do not wait until the panic of a market drop to decide that you've been taking on too much risk.
So, how many of the 12 apply to you?