10 Common Investing Mistakes That Can Set You Back

by Silicon Valley Blogger on 2007-09-2414

It’s not a mistake, it’s a learning experience.

When I first opened an account with my discount broker and started investing, I didn’t realize I’d be committing so many mistakes. But time and experience in the market does help to hone your instincts as an investor as well as make you get a feel for what risk is acceptable to you. By reading a lot of finance and investing books, you can pick up techniques and strategies to employ in order to participate in the market. However, what books and knowledge may not teach you is that investing is a highly customized preoccupation. Everyone has different goals, risk tolerance profiles and basic attitudes about dealing with the stock market, so “investing the right way” may not necessarily be cut and dry.

Take a look at these investing attitudes, beliefs and behaviors that many may believe are “wrong”. But the question is, are these really mistakes or personal choices that can actually be justified? What’s ironic is that when you’re a newbie investor, you are often warned how certain actions can be detrimental to your plan, but as you grow in experience as a participant in the markets, the same actions may be hailed as instrumental to your success. George Soros, anyone?

Typical Investing Mistakes That People Make

personal choices

#1 Thinking that investing is gambling.
I’ve argued with a few co-workers on this subject. Based on their value system, they completely believe that putting money in the stock market is a pure gamble and have even gone as far as claiming that it is an immoral activity. But here’s a table that compares some typical beliefs we have about investing and gambling:

Investing Gambling
A good thing, involves risk. A bad thing, involves risk.
The odds are in your favor. The odds are against you.
Can be addictive and destructive. Can be addictive and destructive.
Is business. Is entertainment.
You save for specific goals, such as retirement. You’re just having fun.
A continuous process of deployment of capital in search of continually increasing net worth. Delayed gratification is implied. A specific act or series of acts, centered around immediate gratification.
Ownership of something tangible. No ownership.
Based on skill and requires the use of a system based on research. Based on luck and emotions.

Though the line between the two can get fuzzy depending on how you approach these activities, I’d go with conventional wisdom on this one and say that investing is a wonderful financial tool if you’re prudent. If you believe that investing is gambling, then you can be missing out on the goodness of passive and investment income; but by staying away from the stock market, you’re being true to your own gut.


#2 Borrowing money to invest it.
Making money by using other people’s money can seem like a crazy idea, since it involves a healthy degree of risk. As a somewhat conservative investor, I always found any form of borrowing to achieve monetary gain to be much too much for my taste. But then I’ve seen how well leverage can work, when done properly. However, the issue here is where we draw the line between foolish leverage and appropriate, well-executed leverage. It’s a mistake if you get into it and you don’t know what you’re doing.

Leverage of any kind can wipe out the unsuspecting and can become serious mistakes pretty quickly if you’re not careful.

#3 Following a hot stock tip.
Investing based on “hot tips” definitely goes into the speculative zone. But if it comes from a reliable source, is it a mistake to follow it? If you research such a tip and found there was merit to it, would you still invest in it? It all depends on where you pick up your information and how you’ve evaluated it. Personally, I’ve made the huge mistake of acting on “advice” in a stock forum where I fell for the classic “pump-and-dump” scam. Definitely a dumb move on my part.

#4 Chasing returns.
When a mutual fund or stock has seen strong days, the temptation is strong to buy into it. But we’re told that it’s not a good thing to chase returns because that could mean buying high. Still, there’s a whole stock buying philosophy based on buying high, which is called “momentum investing”, when stocks are bought based on relative strength. If you happen to be an experienced “mo-mo” investor, you’d be chasing returns all the way to the bank.

#5 Mixing financial vehicles: insurance with investment.
This has always been something I’ve considered a mistake — buying complex financial vehicles that try to achieve multiple goals at the same time. They always turn out to be complex, costly under-performers when seen from their investment angle. For instance, if you buy whole life insurance, you build up a cash value that gets invested. You may find out eventually that it’s not as good a deal as if you bought term life insurance and invested the savings you get from that separately. Surprisingly, a ton of people continue to buy variable and whole life insurance, with many of them justifying it as buying “convenience”.

#6 Following the herd.
Again, we are told time and again that we shouldn’t behave like lemmings while the market zigs and zags. If we blindly sell when everyone sells or buy when everyone buys, we’re bound to get whiplash and lose control of our portfolio. This is emotional investing, and it is dangerous to your money. But following the herd isn’t necessarily a mistake if you’re applying the momentum investing style as a strategy, during which you’re able to capitalize on the power of the herd. Technically speaking, you aren’t using emotion by “riding the herd”, just following technical indicators.

#7 Believing that one can beat the market.
Statistics show that most equity funds are not able to beat the market averages: 86% of diversified U.S. stock funds have lagged behind the Standard & Poor’s 500-stock index over the past 10 years. Yet, most everyone I know says they can beat the market. The truth is, you can probably beat the market on occasion but not consistently. Even I have! Wait, it’s not a mistake if you’re a budding Peter Lynch, right?

#8 Over or under diversifying one’s holdings.
Here is probably the most common portfolio allocation I’ve seen among people I know: how about 10% in high-flying single stocks and 90% in a great bunch of CDs? Owners of these portfolios have proudly told me that by organizing their portfolios this way, they are really controlling their risk while still enjoying the opportunity to do some fun active investing on the side. And they’d have it no other way. To each his own.

#9 Paying too much for the privilege of investing.
Investing requires that we pay out a certain amount to fees and even commissions in some cases. Some people also pay for professional money management and advice. Paying above the norm may feel like a mistake to us in general. However, there are those who are perfectly comfortable to pay whatever a money manager charges when that manager does very well. And if you’re much better off with such a manager steering your money, then why not?

#10 Timing the market and hedging.
Long term investors proclaim that market timing is a bad thing. But those who study indicators will tell you that some amount of market timing can minimize your risk by allowing you to hedge your bets. I’ve also heard it been said that the smart money knows how to time and hedge the market well. This may be true, but it’s not something that should be attempted by ordinary investors. If you want to get in on this type of action, you can always hire an expert to try it out. Good luck though — this expertise does not come cheap. And even if you pay for it, nothing is guaranteed.

-ooOoo-

So what do you think: would you consider these as bad moves or investing strategy? When it comes to money management, anything extreme can be hailed as foolish or erroneous, hence many of these actions can be seen as problematic particularly if applied by a financial novice. However, it’s hard to judge the activities of an investor without seeing the overall context.

The key here is that investing is a highly personal activity, though there are guidelines to help us avoid shooting ourselves in the foot. Here’s how I look at it…

Investing without a plan: if you lose money, it’s a mistake, and if you’ve made money, it’s just dumb luck.
Investing with a plan: if you lose money, it’s a learning experience and if you make money, you deserve it.

 
Image Credit: This is American Soccer

Copyright © 2007 The Digerati Life. All Rights Reserved.

{ 9 comments… read them below or add one }

Meg September 24, 2007 at 9:41 am

I think that whether or not these things are mistakes depends on the investor and whether or not s/he has a reason or strategy associated with the action–if they don’t, then it could be an absent-minded mistake rather than an investing decision

For example, some people DO approach stock investing like gambling. They do little to no research, trade frequently, and try to time the markets. That’s GAMBLING. Others, of course, invest for the long haul in a carefully chosen portfolio designed to meet their goals-that’s INVESTING.

Asset allocation can be a choice or a mistake as well. Having 90% cash is totally appropriate if your net worth is low (like if you’re a recent college grad). You might have $2K in your 401k and $5K in your EF when you are starting out. Or if you own your own company and it grows to be worth millions, 90% of your net worth might be in that one stock. Mistake? I doubt it. Now putting 90% cash in your 401k if you’re 25–that’s a mistake, not a personal investing decision.

david September 24, 2007 at 11:11 am

Nice chart there. But gambling isn’t based on luck and emotion. It is based on statics, percentages, psychology and the odds of the next cards that will be in your favor. If you take a statical approach into gambling it is basically like buying stocks but you win or lose faster.

Raymond September 24, 2007 at 2:48 pm

I personally see investing and gambling as diametric opposites.

In the long run, the odds are against you when you gamble. You may enjoy some short term lucky spurts, but in the long term, your pot size will trend downwards.

When you invest however, in the very long run, the market has almost always trended upwards. You will experience some short term highs and lows, but given a long enough horizon, legitimate investments have always trended upwards cumulatively. The odds are in your favor when you invest for the long term.

Brip Blap September 24, 2007 at 7:10 pm

I’m always amazed at how people say investing in the market ISN’T like gambling. I know people will say you can study companies, the market always trends up, etc. – but it’s not a law of physics. There is no global law requiring the US market to trend upwards eternally. The US is not going to have the advantages it did in the first 100 years of the stock market of economic dominance throughout the world. There is no guarantee – NONE – that the market will always trend up. We all understand and believe the “past performance is no guarantee of future results” line the funds always have in their ads. Why is the market exempt from that as a whole? What about the US economy today makes everyone think that things are going to continue to go bouncily forward forever? Investing is a calculated risk. If there was no risk, there would be no return. Just as with gambling.

Mrs. Micah September 24, 2007 at 7:27 pm

Prosper seems to go both ways–good and bad. But I don’t have the risk tolerance for it any more than I do for gambling. I just think it’s…safer gambling, perhaps.

Borrowing at 13% to invest, as this man was doing, is crazy. Well, it’s crazy to expect to get back your 13% unless you know he has savings to tap into.

Silicon Valley Blogger September 24, 2007 at 10:32 pm

@Meg: Those were exactly the points I hoped to make. That based on individual circumstances, backgrounds, personal perspectives about investing, people will end up choosing different financial plans and strategies to live by and execute.

@Everyone else on gambling: I made a point to state that these are the typical beliefs we have about investing vs gambling. There are of course, so-called “professional gamblers” who seem to make a living on this sort of thing as “experts”. Again, with just enough talent and experience, there may be those who rise to the level of “expert” in their field even as the field is that of gambling. Is this for real?

@Brip Blap: I agree that there’s nothing written that the markets will just keep going up. It’s faith we have that it will, that partly sustains this movement. The biggest reasons it keeps going up are of course rooted in fundamentals. Hence why I like keeping my money primarily in less risky, more developed markets: there’s more assurance there of the steady, upward march of stock prices without the frequent, painful, potentially long-lasting interruptions of collapses brought about by exogenous events and conditions.

@Mrs. Micah: I wish I had more guts to try out Prosper. It’s unfamiliar territory for me, hence I stay away from it. But it seems to work for some people.

MossySF September 25, 2007 at 10:11 am

Investing goes up because humankind continually strives for improvements. 6000 year track record starting from the Sumerians is hard to dispute. Sure there are interruptions — fall of empires, wars, plagues, famine but the general trend is populations and economies to grow. Are we at the limits of this planet? If so, money will be the least of your worries.

Note I said the “world”. If the US economy will not perform like the last 100 years, there’s plenty of other countries to invest in. Surely you don’t have 100% in the US right?

Brip Blap September 25, 2007 at 8:32 pm

@SVB: I won’t argue that faith largely sustains the belief that the value of the market will continue to rise, and maybe faith (and Fed bailouts) will keep lifting it forever and I’ll be proved wrong – that is, of course, my gamble. My comment (mostly in response to Raymond’s comment) is that this faith is similar to the faith a lottery player has in his lucky numbers. Neither the investor nor the lottery player have control – both hope that some external pattern they’ve discerned will make them rich. I know that one is random and one is supposedly based on longer trends and financials and whatnot, but all of the greatest financial minds studying the market thought Enron was a great buy, so financial investing is less of a science and more of a gamble than many people (including me) like to think it is. The biggest trumpeters of the “market will always go up” credo are the big investment banks and mutual funds, who want to keep everyone in the market. That credo gives us strength to carry on even as our country pays daily for an expensive war, a weak dollar and a shrinking hold on economic dominance.

Whew, now I have to take off my tin foil cap, it’s getting hot in here.

@MossySF: I don’t know if you were directing that comment towards me, but I only keep about 30% of my investments in domestic index funds; probably I will only lower that amount in the future. Everything else is bonds (mainly multinationals) and foreign index funds (Europe, Asia-Pacific, emerging markets). I would be hypocritical to claim the US market is not guaranteed to go up forever but be heavily invested in it. I believe a major correction – not a hiccup like the recent one – will occur between now and my retirement in the next 20 years. So I’m putting my money where my lengthy-comment-spouting mouth is… :)

Barbara Stanny September 26, 2007 at 11:28 am

Great list! I loved it…along with your fun choice of graphics.

That said, one of the best ways to learn about investing, or anything else for that matter, is through mistakes. Screw ups can be our best teachers.

That’s why one of the unbreakable rules of investing is this: never put money you can’t afford to lose in any one investment.

Barbara Stanny, author, “Overcoming Underearning.”
web: barbarastanny.com
blog: barbarastanny.wordpress.com

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