Before I sat down to write this article, I compiled a list of dozens of mistakes I have either read about or seen investors make in the 22 years I have been a financial planner. I wish I had the space to share every single one of them with you.
I narrowed my list down to what I feel are the top seven or as I like to call them “the unlucky 7”.
Chasing Performance
Statisticians will tell you that it takes many years to distinguish luck from skill. Nevertheless, some investors are swayed by a short term hot streak. In all likelihood, truly outstanding performance is very difficult to replicate since the conditions that helped generate that performance rarely repeat themselves. Every year presents different challenges and opportunities than the previous one.
Overreacting to Short-term Events
I have talked about this for years. Many investors talk long-term, but act short term. The result is often damage to the integrity of a long-term financial plan and the purchase or sale of an investment at the worst possible time.
Failure to Consider a Comprehensive Financial Plan
Many investors get caught up in considering each of their investments individually or in isolation. A comprehensive plan can help reduce risk, help maximize diversification, and stand the test of time.
Desiring Absolute Returns during Bad Times and Relative Returns during Good Times
Although it would be wonderful to find a manager that always outperforms, in reality that rarely happens. Even Managers who deliver consistent returns with low risk cannot always outperform the market. It is very unrealistic to expect a manager to return 40% during a bull market and lose nothing during a bear market. The answer has always been the same, Diversification.
Hindsight Bias
Consider the following portfolio from 2007. Washington Mutual, Wachovia, Ford, and GM. Investing in these “admired” companies would have turned out to be a disaster in subsequent years. The key point here is that making an investment decision in a real-time setting is very difficult. Nevertheless, many investors assume, after the fact that an investment outcome (e.g., the crash of 2008/2009) should have been obvious at the time the decision was made.
Holding onto Losing Investments too Long
Many investors refuse to sell a losing investment to avoid turning a mistake into a loss. In some cases, realizing a capital loss is the wise thing to do.
Selling Winning Investments too Soon
Imagine purchasing Microsoft in 1986, only to sell it in 1987 for a moderate gain. As long as your fundamentals and goals have not changed, selling an investment early could have a negative impact on the portfolio.