We’ve all heard of them. Friends, neighbors and relatives who have lost everything through a series of bad investments. Individuals beguiled by the promise of high returns who risk everything and come up empty-handed.
The stories are numerous and the investment errors ubiquitous. Knowing what those mistakes are can help improve our decision-making when it comes to investing our money.
Ben Sullivan, a certified financial planner at Palisades Hudson Financial Group in Scarsdale, N.Y., recalls a middle-aged banker who had more than half of his $500,000 portfolio in a few bank stocks. Another prospective client who’d sold his business to a big consumer-goods company had almost all his money — many millions — in that company’s stock. An employee believed his 401(k) plan was diversified because he owned four funds — all large-cap stock funds.
Investor mistakes have predictable patterns, Sullivan says. “Our pervasive emotional and cognitive biases often lead to poor decisions.”
Things to consider:
• Where are you going? Investing is a little like traveling, says Scott Warshaw, financial adviser at First Financial Group in Bala Cynwyd. “You want to figure out your destination first and then work backwards, using a financial plan that will get you there in the shortest time and with the least obstacles.”
It’s important to ensure your time horizon matches your investment objective, he cautions. Is your goal long-term, short-term or intermediate? Once you answer that question you can match it with an appropriate type of investment, be it aggressive or conservative.
• Herd Fever: Staying true to that goal can help investors maintain focus rather than react to short-term events and news, Warshaw says. “My clients say they watch the news stations and I try to remind them that news programs are trying to maintain ratings and keep things interesting. They don’t tell viewers boring stuff like ‘focus on the plan and keep the long-term goal in perspective.’ So stick to your plan and don’t deviate because you heard something on the news.”
Sullivan concurs that following the herd is a powerful emotion “but it leads investors to come late to the party, buying at the top and selling at the bottom.”
• Familiarity: Investing in what you “know best” can be a siren song leading investors astray from a prudently diversified portfolio, Sullivan says. “That was the case with all three investors mentioned above, who were familiar with banks, consumer goods and large-cap U.S. stocks respectively and unwisely put all their eggs in that familiar basket.”
It’s something every adviser will tell you — keep your investment portfolio diversified. “We call that reducing your overall correlation to the stock market,” says Warshaw. “Keep your investments in different asset classes, i.e., stocks, bonds and alternative assets such as commodities and real estate, so that when one asset class is dropping, possibly the others are going up.”
• Be Tax Smart: Always figure out how taxes come into play when investing, cautions Warshaw. “I tell clients, it’s not how much you make, it’s how much you keep!” Many investors will purchase the right type of investment but in the wrong type of account, he explains. A good adviser can usually offer input on this, he says.
• Know Your Risks: Risk is fine for certain portfolios as long as you understand the risks you’re taking, says Adam Stern, CEO of Aegis Ventures in New York. “If you can’t afford risk, you should not be investing in speculative investments. People make investment mistakes when they haven’t done appropriate homework, or they’re not relying on experts, or they’re making decisions based on what they read in a news article or saw on a TV headline. Instead, you need a long-term plan based on the age, risk profile and assets of the individual.”
Many investment mistakes occur when people lose sight of their end objective and act in the moment, Warshaw says. “They deviate from a strategy that’s considered slower but safer, because it’s well diversified, and buy one or two stocks because they think they can make a lot of money fast. But with more reward there’s almost always more risk.”
• Manage Your Expectations: If your expectations are unrealistic, you’re likely to be disappointed, Stern suggests. “Managing expectations is one of the critical aspects of being an investor.”
“We all bring our natural biases into the investment process,” Sullivan agrees. “Though we cannot eliminate these biases, we can recognize them and respond in ways that help us avoid destructive and self-defeating behavior.”
If you can’t control your emotions or don’t have the time or skill to manage your investments, a fee-only financial adviser is a good idea, he says. “An adviser can provide moral support and coaching, which will boost your confidence in your long-term plan and also prevent you from making a bad, emotionally driven decision.”
South African native Lauren Kramer is an award-winning writer based in Western Canada. This article originally appeared in "Financial Health," a special section.