8/27/2013 4:45 PM ET|
7 of the most common investment mistakes
There is no computer program or individual that will make all the right investing decisions all of the time. Here are the some common mistakes investors make.
In life, mistakes happen. The same is true in investing. With all of the historical data and experience we possess there is still no computer program or individual that will get it right all of the time. This is because investing contains uncertainty. Moreover, investing is an emotional endeavor, especially when the money was the product of years and years of hard work and discipline. In this article, we'll examine some common mistakes investors make.
Mistake No. 1: Making emotional decisions
It's true that investing is part science and part art. Because of this, generally speaking, successful investing should contain elements of each. Decisions made purely by emotion can bring disastrous results, just as decisions made only from a computer program can also pose a problem. Emotional decisions are often tainted with biases. For example, when investors buy a particular investment and it subsequently rises, they may adopt the belief that they were sure that would happen. Conversely, if the investment declines, they may convince themselves that they had a hunch that could happen as well.
This inconsistency is because human behavior has a tendency to arrange our thoughts to fit the thesis of the moment. This is where 'behavioral finance' enters the picture. Psychologists have identified a number of human biases which explain certain inconsistent patterns of behavior. The truth is, good investment decisions contain elements of number crunching as well as human reasoning. And, although it's important to recognize this, it's much easier said than done. Now, let's move on to mistake #2, holding a losing investment too long.
Mistake No. 2: Hold a loser until It breaks even
I've seen this a number of times over the years. The storyline goes something like this. I bought an investment and it lost value. Now it is down 20%. But when I bought it, I believed it was a good investment. Therefore, I'm pretty sure it will rebound and when it breaks even I'll sell it. The truth is they will probably not follow through. Why? Because, if and when it comes back, they'll hold it, believing it will continue to rise, reinforcing their initial belief that it was a good investment decision. Here's the problem.
If the individual were to sell it at a loss they would be forced to admit that they made a bad decision. And admitting this is very difficult for some. In reality, sometimes it's best to cut your losses and move on. Now let's look at mistake #3, impatience.
Mistake No. 3: Impatience
Investing requires a great deal of patience. Conversely, making rash decisions, in any endeavor, can be problematic. Most of us have been trained by society to expect "instant gratification." The truth is, life doesn't work that way and neither does investing. Investing requires patience. For example, there are numerous instances where an investment severely lagged for several years before it turned around and became a top performer.
This is not at all unusual. Therefore, assuming you have chosen a quality investment, to maximize its return you need to be prepared to hold it through a complete cycle to allow the manager's strategy to play itself out. How long is a complete cycle? This can only be answered after the fact. It's the same with identifying the end of a recession. It's normally several months after the fact before we realize a recession has actually ended.
Mistake No. 4: Placing too much importance on past returns
When selecting an investment, don't rely solely on past returns. For example, if you're buying a mutual fund it's important to evaluate how the manager performed during a bad period in the markets, such as 2008. My clients, on average, lost 16.25% that year.
There were a number of reasons why it wasn't worse, but here's the point. When you look at a mutual fund's performance during a bad year, if you find they lost markedly less than similar funds, it may be an indication that they have strong risk management controls in place. The importance of this cannot be overstated, especially when the next downturn occurs.
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You don't have to take a profit in a stock if you evaluate it as being as good an investment as anywhere else you might put your money. Warren Buffett's operated that way for decades. Why pay the capital gains if it's a taxable account?
About holding a stock too long: I have a personal rule to sell a 25% loss, but only if a one-time event isn't responsible for the drop like the 2008-9 crash or the Japanese Tsunami. The people who followed the drop-it advice given here are those whose retirement accounts are screwed because they missed the market recovery.
In the late 90's the Cracker Barrel Old Country Store stock I purchased for $17 several years earlier dropped to $9 because forest fires in Florida closed a significant number of stores. I held it because it was a one-time event. A couple years later it was $40. It's around $100 now - and I still own it.
Good, timely article by Mike Patton. Lots of good advice and common sense there.
Equally good response from "The Mick". I too have personal rules, my discipline as it were, that have served me well over the years. Those occasions where the market did hurt me usually resulted from failure to follow my own rules. Emotions can be a lousy steward when it comes to running your own money.
One thing I've never figured out is knowing when to sell when riding a runaway growth stock like Netflix or Tesla. Obviously, the valuation metrics are ridiculous, but those investors who bought early-on in these names have seen unbelievable gains. But now, how does one know when to sell so as to turn those paper gains into realized profits before Mr. Market takes them back? That's a hard call to make no matter how much discipline one has.
I'm still working on this one. Any thoughts or ideas out there? Care to share?
"Mistake No. 2: Hold a loser until It breaks even"
This mistake actually paid off pretty well for me recently in the silver market. I like making those kinds of mistakes. And you’re right, I’m still not selling all of it.
Every asset class is a good investment. The profits are made in making the right decision if that asset class is going up or going down. You buy long if it's going up, or you short it, if it's going down.
The risk is deciding if that asset class is already too high or too low. It's easy when the class declares itself, such as a record low, or a record high. Does that mean it won't go down more if it's at a new low or not go up more with a new high? No, but the probability and risk is higher than to expect an inevitable reversal once a record peak or trough is made.
Every investment can be profitable IF you buy in the direction it's going.
Whenever I make investments, I assume that the gap is highly likely to close in three years or less. My own experience as a professional investor over the past seven years has been that the vast majority of gaps close in under 18 months."
Decent Article by M. Patton......Investors or others new to the game, should probably read over the 7 ideas about 3 times each, for " memory imprint"....Will give you a good start.
A couple I will pass on that are relatable;
Never have understood, why an investor would want to jump in at "ultimate tops."...#7
Unless for knowledge on the "inside."
"Know when to hold them, know when to fold'em."...#2 and #6.
And of course the old Sage's advice on "Buy and Sell on the Fear and Greed" mantra...WB.
People that didn`t believe in Obama in 2009 cost 90% gains before dividends.My Republican
relatives really feel stupid for missing gains of a lifetime.
Seven biggest mistakes in investing.
2.) Trusting Wall St.
3.) Insert item#3 into slots #4 through #7
Don't forget - it's okay to invest in a restaurant chain even if the colored customers threaten you.
Then again - there is always Raytheon.
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