What are the most common mistakes that individual investors make during their investing lifetime? Before you continue to read this post take a pause and think for a moment. I am sure you have come up with the most common one (or perhaps many common mistakes). Now read on and compare what I have below.
I have observed that individual investors make two most common mistakes (1) False impression about performance expectations; and (2) Misunderstandings about securities market.
False Impression about Performance Expectations
- The biggest mistake I find is lack of well-defined plan. A well thought out plan will be based on time horizon, risk profile, risk tolerance, and available resources.
- Investor’s also demonstrate lack of discipline in their execution process. Investing is all about long-term process, but investor’s rarely demonstrate the patience for long term.
- Investor’s fall in love with a given security due to lack of an exit plan. If your investment fails to meet your buying objective, then it should be removed from the portfolio. I admit this was one of my own mistakes.
- The securities markets move up and move down. They are cyclical with varying duration and have different crests and troughs. This applies to every asset class.
- Different asset class must be evaluating based on different performance parameters. Since they are designed for different purpose, why use the same performance measures. Differentiate between investments for capital gains, income producing cash flows, following market performance, etc.,
- There is no one-size-fits-all. Each asset class has different objectives and different expectations.
- Investor’s understand asset allocation only partially. They miss the last chapter on asset allocation – i.e. timely rebalancing. When a asset allocation is out of whack, investors fail to sell winners, instead they focus on downers and incur more negative performance. This was another of my mistakes.
- Individual investors following buy, hold, and sell recommendations from institutional investors.
Misunderstanding of Securities Market
- Investors fail to understand the difference between asset allocation, asset class, and diversification. Asset class and asset allocation is related to stocks, bonds, savings, real estate, etc., Diversification is related stocks with market capitalization (large, medium, small), style (growth, blend, value), and industry sectors. The objective for using asset class and diversification are different.
- Investors get into the game of predictions which seldom works. It is acceptable to have expectations. In essence predictions and expectations are same. Investors fail to differentiate between speculation driven analysis (predictions) and data driven analysis (expectations).
- Mutual funds, exchange traded funds, exchange traded notes, closed-end funds, futures based funds and securities, currencies, etc., are all menu of choices designed for different groups of investors. They are not for all investors. We do not eat every item on menu list. We may try and taste different items once in a while, but in the end, we stick to selected few.
- Investor’s fail to understand that every asset class has different time horizon and risk factors.
- Media sensationalism driving misconceptions about how securities react to economic and political environment.
I believe that not all ‘investment mistakes’ lose money. However, all investment losses are due to mistakes in our own ‘investment processes.
So does your listed mistake fall in one on these? Let me know by leaving your comments.