10 Common Investors Mistakes

Everyone makes mistakes, but knowing what can go wrong puts you one step ahead. Here are 10 common mistakes investors make. How many of them apply to you? Here’s where your investment manager can really add value.

No investment strategy. From the outset, every investor should form an investment strategy that serves as a framework to guide future decisions. A well-planned strategy takes into account several important factors, including time horizon, tolerance for risk, amount of investable assets, and planned future contributions.

Investing in individual stocks instead of in a diversified portfolio of securities. Investing in one or a few individual stocks increases your risk. Investors should maintain a broadly diversified portfolio incorporating different asset classes and investment styles. Failing to diversify leaves individuals vulnerable to fluctuations in a particular security or sector.

However, it is also possible to over-diversify and own too many investment products − particularly if an investor has a modest portfolio. This unfocused approach will generate higher overall fees and is less strategic. The best course of action is to seek a delicate balance between the two. Often, this can best be done with the advice of a professional or trusted advisor.

Investing in stocks instead of in companies. Investing is not gambling and shouldn’t be treated as a hit-or-miss proposition. When you invest, you assume a reasonable amount of risk to help finance enterprises you believe have positive long-term growth potential. Before buying a stock, analyze the fundamentals of the company and industry, and make sure it has basic corporate governance protections. You shouldn’t look at day-to-day shifts in stock price. Buying a particular stock because it looks like it's going up or because you like a company’s product or service is not a sound investment strategy.

Buying High. The fundamental principle of investing is buy low and sell high. So why do so many investors end up doing the opposite? The two main reasons are performance chasing and following investment fads. Just because a stock, a fund or an industry has done well in the past, is no indication of future performance. Similarly, buying a popular stock often leads to investing at the height of a cycle or trend – just in time to ride it downward.

Investors often end up buying high and selling low because they think short term instead of maintaining focus on their long term investment strategy. This is tactical, not strategic investing. Investors should not draw conclusions from the past but always look critically at the prospects for future performance past.

Selling Low. When a stock goes down, too many investors are slow to cut their losses and sell -- they hold on hoping to regain at least some of what they have lost. Smart investors realize that may never happen. Not every investment will increase in value and even professional investors have difficulty beating the S&P 500 index in a given year. Always have a stop-loss order on a stock. It’s far better to take the loss and redeploy the assets toward a more promising investment.

Churning your investments. Trading too frequently cuts into investment returns more than anything else. A study by two professors at the University of California at Davis examined the stock portfolios of 64,615 individual investors at a large discount brokerage firm between 1991 and 1996. The study found that, without transaction costs, these investors received a 17.7% annualized return, which was 0.6% per year better than the stock market itself. But, after transaction costs were included, investors' returns dropped to 15.3% per year, or 1.8% per year below the market. The solution is a long-term buy-and–hold strategy, rather than an active trading approach.

Acting on “tips” and “soundbites.” While breaking news and insider tips may seem like a promising way to give your portfolio a quick boost, always remember you are investing against professionals who have access to teams of research analysts. Too many investors use the media as their sole source of investment thinking instead of pursuing a professional relationship with an advisor. Seasoned investors gather information from several independent sources and conduct their own proprietary research and analysis before making an investment decision.

Just because information is new to you doesn’t mean it's really new. You can be sure that if you’ve heard it, so have many others. That means the information is likely already factored into the market price.

Paying too much in fees and commissions. Incredibly, investors are often hard-pressed to cite specifics on the fee structure employed by their investment service provider, including management fees and transactions costs. Before they open an account, investors should make sure they are fully informed about the expenses associated with every potential investment decision. To really gauge your overall performance, adjust all your investment returns for fees and expenses paid.

Decision-making by tax avoidance. While you should be aware of the tax implications of your actions, the first objective should always be to make the fundamentally sound investment decision. Some investors, to avoid capital gains tax, will allow the value of shares in a well-performing stock to grow to account for an inordinate percentage of their overall portfolio. Similarly, don’t hold on to a security past the one-year purchase date simply to take advantage of a lower capital gains rate. If you are concerned about tax, find a good tax advisor – don’t let it change your investment decisions.

Unrealistic expectations. Expecting returns of 20-25% annually can only result in disappointment or excessive risk-taking. According to Ibbotson Associates, the compound annual return on common stocks from 1926-2001 was 10.7%, but only 4.7% after taxes and inflation. Returns on long-term bonds over the same time period were 0.6% after taxes and inflation. It is important to take a long-term view of investing and not allow external factors to cloud actions and cause you to make a sudden and significant change in strategy.

Neglect. Individuals often fail to begin an investment program simply because they lack basic knowledge of where or how to start. Likewise, periods of inactivity are frequently the result of discouragement over previous investment losses or negative growth in the equities markets. To be certain, investors should continue investing in every market − albeit through different investment vehicles − as well as establish a mechanism to make regular contributions to their portfolios. Investors should also regularly review their holdings to ensure they are adhering to their overall strategy.

Not knowing your real tolerance for risk. There is always risk in investing. Determining your appetite for risk involves measuring the potential impact of a real dollar loss of assets on both your portfolio and psyche. You should be realistic and evaluate your level of risk tolerance and invest accordingly. In general, individuals planning for long-term goals should be willing to assume more risk in exchange for the possibility of greater rewards.



Content adapted from CFA Institute

CFA Exam Prep Level 1

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