The Seven Deadly Sins of Investing
The Wall Street Journal had a recent article called “The Seven Deadly Sins of Investing.” I have written about all of them on my blog posts at some point or another. But the Wall Street Journal article sums it up nicely, so I thought I would recount them here.
One of the main points of the WSJ article, which I agree with, is that even after some time has passed since the financial crisis; investors still make the same kinds of mistakes that have gotten them in trouble for decades.
Below is listed the most egregious ones.
- Chasing past performance
- Being Overconfident
- Overlooking costs
- Wanting to join the club
- Unable to admit failure
- Living for today
- Following the herd
Chasing Past Performance
This concept which I am sure almost everyone has heard of is another description of “Recency Bias.” I devotedly an entire blog post to this idea. Rather than repeat it here, you can read this post here, Recency Bias.
Being Overconfident
This mistake is simply thinking that you are as smart as the market is. This can be avoided by having another source to bounce your ideas off of. I don’t mean talking with your uncle Bob. I mean talking with a “knowledgeable resource.” This can be an investment advisor, a financial planner, or just a subscription to an unbiased investment newsletter. This is what I do. I subscribe to Morningstar which is a very comprehensive online newsletter that gives unbiased opinions on individual stocks, mutual funds, ETFs, etc. In my opinion it is certainly worth the annual subscription fee.
Overlooking costs
This is a big mistake that most investors make. However, it is more costly to younger investors. Rather than go into detail on why investment costs are so important, you can click on The 3 biggest investment mistakes made by young people” to read why. I also touch on investment costs as they relate to retirement income withdrawal rates in this post, Retirement income and portfolio expenses.
Wanting to join the club
This mistake is not common for the average investor. But it is still a temptation for some. Examples of this mistake are wanting to be “in” on the Facebook IPO or, because he gave the air of exclusivity, wanting to have Bernie Madoff as your portfolio manager. We all know how these two things turned out.
Failing to Admit Failure
People hate to lose money. Another word for this is “Loss aversion.” Investors held on to tech stocks as they plummeted during the crash of the early 2000s. Ditto for financial stocks during the 2008-2009 financial crisis. This is why many investors place stop-losses on their stocks to avoid this mistake of letting loss aversion destroy your capital.
In any major market downdraft, unless you have a very good reason why you should not sell a particular stock, then you should sell it after a certain amount of loss. Stop-losses help you manage your emotions and maintain discipline in this area.
Another approach is to do what I do. I never buy high volatility stocks like Netflix or Salesforce.com. I only buy blue chip stocks that have survived the test of time and that pay very consistent dividends. In 2000 and in 2008, I never sold any of my stock holdings such as JNJ, WM, NVS, CPB, XOM, ABT, KO, etc. I did not use stop losses on any of them and, in fact, during each market crash I bought more of them. The only time I will consider selling one of these stocks is if a company decreases their dividend or does not raise it over a couple years as this is a real sign of trouble.
Living for Today
I think anyone reading this blog knows about this mistake. If it will help some get a better idea if they are making this mistake, read this post that I wrote a couple years ago. It will give you an idea if you are on track toward your retirement goals.
A recent survey by the Employee Benefit Research Institute of U.S. worker’s savings found 57% reported less than $25,000 in total household savings and investments, not counting their house or defined-benefit retirement plans. You do not want to be part of this crowd. If they don’t significantly change their actions very soon, many of them are going to have a very difficult time in old age.
Following the Herd
This is perhaps the most common investing mistake of all. When the stock market tanked during the 2008 financial crisis, many investors fled, some abandoning their entire portfolios and putting the money into cash. Everyone was panicking and it seemed logical to follow the herd and do the same. As the recent markets have shown, this was a very expensive mistake.
To battle the fear that inevitably comes with a market decline or other adverse events, financial advisers say it is crucial that investors have a detailed portfolio plan that they stick with regardless of short-term events. I explain how I maintained my cool and my investing discipline in my post How the Financial Crisis moved our Retirement date forward by 2 Years. The key is proper equity allocation based on your risk tolerance and periodically re-balancing your portfolio regardless of what the market is doing.
That is it. If you avoid making the above mistakes, your investing will have better returns with less risk.
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Ted your blog is very informative and I enjoyed reading it. I also looked up the sailing blogs and the pictures. You and Dena are living a great retirement!