Common investor mistakes

What are the most common investor mistakes?

October 17, 2014

This week I was asked the question, “What are the most common mistakes investors make when investing online?

The challenge with answering is trying to fit all my thoughts into 700 words.  Let me start by saying that the mistakes online investors make are simply a turbocharged version of the mistakes all of us make as investors.

This list is not meant to be all-inclusive or all-encompassing, and I welcome your comments on the many things I’ve missed out.  However, I think this is a good start…

1.  Having no overall plan:

As you know, my belief is that much greater success can be achieved in less time when people take the time to get clear on their highest priority goals and objectives.  When specific dates and amounts are put on those goals, a detailed financial plan can be developed to achieve them.

The investment plan will fit into this overall plan.  Specific to investments is a clear idea of the time horizon for each component, the need for liquidity and income from the portfolio, and your risk tolerance.

These are the factors that should be clarified, confirmed and written down before deciding on investments.

2.  Failing to understand risk:

There are two aspects to this.  One is emotional and one is analytical.

When emotions are combined with market volatility, mistakes are made.  The emotion that most people experience when the market drops is fear.  When the market has fallen significantly, that’s actually when greed should take over, investing in stocks at bargain prices when others are panicking. 

When the market has been rising steeply for a long period of time, that’s actually a time to be a little more cautious, while most people then tend to get greedy and want to chase those high returns, buying high.

The analytical aspect of risk is that losing money is expensive (both emotionally and financially), and it takes a lot more to earn it back.  For an extreme example, if an investment falls 50% from the price paid, then it must earn 100% to recover the original price.

While market volatility can be your friend, allowing you to purchase investments at attractive prices, permanent loss of capital is definitely your enemy.

Be realistic about your psychological risk tolerance, as well as your financial ability to withstand fluctuations in your portfolio.  For example, if you are retired and comfortably living off the dividend income from your portfolio, there’s no reason to invest in small-cap stocks or junior mining stocks, where a loss of capital can be permanent.

On the other hand, owning high quality, mature, dividend-paying companies might be perfectly appropriate, as they provide the tax advantaged dividend income you need to support your lifestyle.  The fluctuations in stock price like we’re experiencing this month are temporary setbacks that do not affect those dividends.

3.  Market timing:

Speaking of market volatility and ups and downs, much of that should be ignored.  Your mix of stocks, fixed income investments and “cash” should always be based on your situation - your time horizon, your need for liquidity, your need for income and your personal and financial risk tolerance.  Your investment decisions should not be based on whether or not the market is “up” or “down”. 

As a reminder, never invest in fluctuating investments over a time horizon shorter than 3 to 5 years.  That’s a huge mistake.

Paying too much attention to daily headlines, the financial media or investment managers who are looking to get publicity or make a name for themselves is another classic booboo.

Rats… We’ve run out of room before we run out of mistakes.  So, let’s turn this into a positive outlook, and say the following:

  1. Invest with a plan.
  2. Always invest appropriately for your time horizon, even when you have several different time horizons for different goals.
  3. Understand risk, both conceptually and how it can affect your actual portfolio.
  4. Design an investment portfolio that will help you reach your personal goals and objectives, with liquidity and income designed to fit your particular needs.

Do all that, and you will sleep well.

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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.

Please consult legal, tax and investment experts for advice on your unique situation.

David Christianson, BA, CFP, R.F.P., TEP, CIMis a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.