Top Ten Mistakes that Investors Make

For our Top Ten Thursday, we're going to come back to the topic of investing.  I have met and worked with many successful investors.  I have also met and worked with investors who can't help but shoot themselves in the foot.  What is the latter group doing so badly?  In many cases, they're probably over thinking things.  But that's not one of my top ten.  Here's the list:

10.  Getting emotionally attached to a stock.  Most people don't even realize when they have fallen in love with their stocks, but you see it when they struggle to sell.  This is especially common when people receive stocks as gifts or inheritance.

9.  Trying to "catch a falling knife."  Stocks on their way down often continue to go down.  Remember when JDSU reached $300 and people started buying it at $100, or $60, or even $12 telling themselves, "How much lower can it possibly go?"

8.  Blindly shadowing others trades.  Joe from the office has done well, and he's buying XYZ.  I guess I'll buy XYZ.

7.  Not thinking long term.  Investors who bail at the first sign of a short term loss are likely to struggle to achieve long term gains.

6.  Buying low priced stocks.  Investors tell themselves, "Oooo, it's only $3.24 per share.  I can buy 500 shares!"  The thinking is that it is easier for a $3.24 stock than a $32.40 stock to double in price.

5.  Mistaking greed for high risk tolerance.  I remember in 1999, everyone I talked to said that they had a high risk tolerance.  What they really meant was, "I want to make a lot of money!!!"  They didn't even believe that the market could go down like it did.

4.  Thinking they're diversified, when they're not.  I remember in early 2000, shortly after the Wall Street Journal had come out with their year end Mutual Fund review.  A woman walked in and had highlighted all ten of the "top performing stocks" for the prior 1 year.  Little surprise that they were all either Large Cap Growth funds or Tech funds.  She wanted to invest a little in each one of them.  To invest in only one or two didn't seem diversified enough for her.  I assure you that if we looked at the top ten holdings of each of those funds, you would see many of the same companies over and over.  I'm also sure that each of the funds on that list suffered mightily in the months and years to follow.

3.  Chasing performance.  I could tell the same story about the lady who wanted to buy last year's top mutual funds all over again.  History shows us that assets classes rotate in leadership.  What led last year is not likely to lead again the following.

2.  Being too conservative.  In What is Risk?  I explained that there are different types of risk that investors face.  The easiest one to understand is principal or market risk.  The risk that your balance declines in absolute terms.  However, by being too conservative, your biggest risk is purchasing power risk.  This is the risk that your money doesn't grow fast enough to keep up with inflation.

1.  Paying high fees or expenses for load fund, annuities or insurance products.  I'm not saying that you should never invest in these types of products, but understand what all of your expenses are, how the rep who is recommending them is getting paid, and why it is the best choice for you over a no load or lower expense option.

By the way, this is not investment advice, financial advice, or a solicitation to invest or buy any investment products whatsoever.  Just some rambling thoughts.

Have you seen or made some mistakes that are not included on my list?  Let's hear 'em!

Comments

[Canadian Capitalist]

I would add not benchmarking their portfolio returns to a simple diversified portfolio of index funds to the list. Too often, I hear investors brag about the killing they made on a stock. Left unsaid is the many stocks that were just stinkers. My bottomline is, if I can't beat the market fairly consistently by at least a few points, it is far better to invest in index funds and be done.

[Ricemutt]

Personally, my biggest risk is probably #2. But the biggest risk overall that I see (and isn't overtly listed here) is not doing enough research before investing. People put more effort researching their next TV than their next stock purchase. Making money isn't an easy task. Why should investing be any different?