"Are You Kidding Me!?" 5 Common Investing Mistakes
If you ask the average investor why they made a specific investment decision, they will probably tell you it was to either make money, or to not lose money. However, there are deeper psychological factors at play. Often times, investor decisions are driven by influences we call "behavioral finance" and therefore, aren’t always sensible or logical.
This is one of the reasons working with a financial advisor can be beneficial – a financial advisor can bring an objective, well-informed perspective to your finances. You may think you’ll be able to keep your emotions at bay, but optimizing your personal finances can churn up all sorts of emotions. We work hard for what we have, and the idea of losing it understandably causes people to panic.
What actually drives our investment decisions? Watch our short video:
Why We Make the Decisions We Do: Behavioral Finance in Action
As a financial advisor in Houston, TX, we frequently see 3 common motivations that lead to investing mistakes.
Motivated by Herd Mentality
You can probably guess what herd mentality is. But you’ll probably be surprised to learn how common it is. When the market becomes bullish, bearish or otherwise volatile, many investors will simply follow what the masses are doing, be it from panic, irrational exuberance or something in between.
Instead of looking at the actual economics of the market, many investors will join the “herd” in buying or selling, exacerbating what the market is already doing. Today's 24/7 financial press that is compelled to "say something" every day does not help stem this tendency and lead readers to more grounded decisions.
Motivated by Anchoring
Anchoring is becoming overly attached to particular stock market news or events, while ignoring other elements that might be just as significant.
For example, suppose an investor lost money during the dot-com bubble. If they “anchored” to this period of time, they might also become anchored to that memory and remain forever skeptical of technology stocks and innovative new technologies that are still early in their adoption. It’s wise to learn from your mistakes, but becoming irrationally fearful can cause you to miss out on truly valuable stocks that report viable revenue and staying power.
Motivated by Confirmation Bias
Confirmation bias can occur within any walk of life that requires analysis. Whether it’s investing, political theory or anything that requires critical thinking, people have the tendency to seek out or acknowledge information that confirms their existing beliefs. If you invest with a confirmation bias, you may inadvertently make yourself close minded to all available investment opportunities, limiting your future wealth.
There are many facets to behavioral finance. Working with a financial advisor can help you substantiate your financial decisions with facts, data and investment knowledge.
Now that we’ve explained some of the reasons we make common investment mistakes, let’s take a look at what these mistakes are.
1. Over-concentrating your investments
Investment overconcentration occurs when you have too much of your wealth tied into one stock or sector of the market. This essentially puts all your eggs in one basket.
For example, say you’re overly invested in technology stocks. The good news is the technology sector rallied more than 30 percent in 2020, beating the S&P 500. In this scenario, there’s a good chance that your portfolio saw some exciting growth. However, if technology stocks fell, your portfolio would suffer.
In our 50+ years of helping clients, we find that we run into over-concentration surprisingly often. Many times, it results from working for a company for a long period in your career where part of your compensation is in the form of company stock. You can become "wed" to that stock, allowing it to become too large a percentage of your total wealth.
Overconcentration is extremely risky, though extremely common. Decisions like following a “set-it-and-forget-it” strategy, forgetting about an investment you made, or simply not adjusting your investments can cause your portfolio to drift into overconcentration territory. This can also happen at year’s end due to outside factors. Read our recent blog post: Market Seasonality Factors: What This Means for Your Investments.
2. Timing the Market
Timing the market is extremely difficult. Nonetheless, the desire to try it has incredible emotional appeal to many people! No one has a crystal ball to predict what the future holds – we’ve looked! (One of our clients, upon hearing that we had no crystal ball, went online and jokingly ordered a crystal ball and had it shipped to the firm as a gift. We keep it on the table in the Investment Committee's meeting space. But so far, it has not provided us any sharp insights!) You can certainly try market timing and you may get lucky, but long-term investing isn’t gambling! (Read our recent blog post: Why Long-Term Investing is Different Than Vegas.)
Talk to a financial advisor about your investment strategy. If he or she promises specific returns, get a second opinion!
3. Avoiding the Stock Market Altogether
All investment carries some amount of risk, but waiting on the sidelines for too long carries inherent risk as well.
Playing it “too safe” can result in missing out on potential returns. One of our wealth advisors met recently with a prospective new client going through a divorce and property settlement negotiation. This couple, divorcing in the early 40s, had been very effective savers, but because of great fear of market risk, had kept their entire family savings in bank savings instruments at progressively lower rates of interest over the past decade. As part of the settlement negotiation, we prepared a model of what "could have been" had the couple's money been invested in a more balanced growth and income strategy over the previous 15 years, compared to being parked in cash instruments. The family wealth to divide would have been $3.7 million instead of $2.2 million. That is a high price to pay for avoiding market risk. Saving your money in a can under your bed may save you from loss, but will you be able to keep up with inflation? Probably not.
Fear isn’t a strategy. Talk to a financial advisor you trust and understand the risk different investment strategies carry. Find your true risk tolerance. Discuss your purpose for investing and incorporate investment strategies that help you reach your goals while feeling confident and comfortable with your decisions.
4. Panic Selling
The moment the market starts to show any hint of weakness, panic can set in. But making a quick, emotional decision based on fear opposed to taking the time to understand what’s really happening, can cripple your portfolio strategy and cause you to sell your investments too soon.
If markets begin to drop, take a deep breath and try to understand the cause of volatility. Invariably, short-term fears create market sell-offs that do not sustain themselves as permanent losses of capital. Lean on your financial advisor in times of uncertainty and remember your long-term goals. What you don’t want to do is panic sell, just to buy back in later if the market rebounds, essentially buying high and selling low. Just as fear is not a strategy, neither is panic a strategy.
5. Waiting to Break Even – It May Not Ever Happen
When a stock loses its value, playing the “I'll wait till it comes back to sell” game can be an uphill battle.
Don't ever lose sight of the math of price recovery. Suppose your favorite stock fell 50 percent in six months. In this case, it would require a 100 percent return just to break even. Do you reasonably believe that your stock will go up 100 percent? Are you willing to wait another six months (or more) just to break even?
Don’t let your ego or an emotional attachment to an investment cause you to hold a bad pick. Yes, investing requires patience. But failing to sell a bad investment can keep your capital unnecessarily tied up.