Everyone makes mistakes. That’s part of being human. However, limiting big investing mistakes starts with awareness of what to avoid when it comes to your hard-earned money. If you can sidestep these investing mistakes, your path to financial success will be an easier journey.
Every mistake made can be a setback and compound against you. Your goal is to keep mistakes to a minimum so assets can compound for you over time. In other words, make money work for you most efficiently.
In part one of this two-part blog series, we will cover some common big investing mistakes so that you can be prepared for any investment challenge thrown your way.
Let’s dig into part one of the big investing mistakes to avoid.
Investors typically tilt their portfolios towards their home country. Why? Because it’s familiar. This results in over-exposure to the country of residence and insufficient exposure to the rest of the world. There is an entire world out there to invest in. Use it!
You don’t have to stay within the boundaries of the U.S when it comes to investing. You might ask, “why would I invest outside the U.S. when it has outperformed the rest of the world lately?” The U.S. has indeed outperformed the rest of the developed world as a whole over the last decade, but that doesn’t mean it will continue. The developed world (ex U.S.) and the U.S have gone back and forth in historical performance, so don’t base your allocation on recent performance.
Consider the graphic below from Alpha Architect. You never know when the U.S (SP500) will outperform the developed world (MSCI EAFE) and vice versa.
Rebalancing is a form of risk management. This means buying or selling investments to get your asset allocation back in line with your target investment mix. Unfortunately, many investors fail to rebalance or check their asset allocation, which creates an out-of-balance portfolio. The more time passes, the more a portfolio allocation can drift outside of a target allocation or risk preference. When an asset allocation is outside of an investor’s risk tolerance, it can result in undesired investment decisions during times of market volatility.
Don’t rebalance too frequently. Instead, have a rebalancing strategy that works for you on a predetermined schedule — annually, semi-annually, or when your investment allocation gets outside of a certain threshold.
This one is easier said than done. It’s fun to watch your investments go up in value, and it’s ok to check your account. In fact, you need to stay on top of your investments to manage them properly. But don’t look at your investment balance or performance every single day. The ups and downs of the stock market will drive you nuts in the short term. Not to mention, the more you look at it, the greater chance you’ll take unnecessary action.
An interesting story to share — A study between 2003 and 2013 by Fidelity (which some say didn’t happen and I cannot find the actual data) showed the best performing accounts were inactive accounts! Which emphasizes the importance of checking your account less often and keep your eye on the long term.
The best investment allocation is the one you can hold onto. Know how much risk you can (and need) to take. Many investors overestimate their ability to stomach large moves in the stock markets. Then the stock market enters a bear market; they find out too late that their investment mix was too risky. This might result in making big portfolio changes at the wrong time. Big portfolio adjustments during market downturns can negatively impact your long-term investment performance. Too much risk can go unnoticed during a long bull market, and it can be a performance killer during a bear market.
Just like taking too much risk, it’s possible to take too little risk. Investment returns don’t come without some form of risk. Risk is what you pay to get a future return on your money. If there were zero risks, there would be zero returns. If you hold an excessive amount of cash or conservative investments, your money might not have the opportunity to grow enough. Balance your portfolio with the right amount of risky (#4) and conservative assets, so your money can grow enough to provide you with future financial flexibility.
At some point, you might or may already have taken a shot at earning a quick buck from a stock tip, forum, or recent shiny investment you saw in the media. If you make money on a stock or flyer investment, great! But don’t confuse getting lucky and being skillful.
Having a skill is the ability to know how to do something and do it effectively. Stock picking, for most of us, is a hard game to win over the long term.
When the stock market is in a long bull market, everyone appears to be a genius investor! This is because everything (just about) is going up. This can cause investors (or traders) to think they have a certain level of skill in selecting investments that perform well.
Sometimes we all need some luck! Just don’t get caught up in thinking you can repeat something that was more luck than skill. Successful investing is about having a repeatable process that can compound over time. Luck is hard to repeat. Have a long-term investing strategy and let the stock market do the heavy lifting.
Picking funds (or stocks) based on recent investment returns and expecting the same in the future is a potential recipe for disaster. By looking at recent historical performance, you start in the rearview mirror. Historically, a period of above-average returns is typically followed by below-average returns. This is called “reversion to the mean.”
Fear of missing out (FOMO) is also a way of performance chasing. You may notice the latest and greatest stock or fund performance and feel you are missing out on big returns. Maybe you jump in at the right time, but don’t expect it to end well if you don’t understand what you are getting into.
If your portfolio is properly diversified and you have an investment philosophy in place (that you stick to), you are less likely to chase performance.
If you feel the need to invest in the next hottest thing (or chase performance), set aside 5% of your portfolio for these opportunities. This will ensure that 95% of your money is still working to build long-term wealth. Of course, losing half or all of 5% of a portfolio isn’t going to wreck your investment plan. On the flip side, a big return on a 5% allocation is still great!
Yes, it’s possible to diversify too much. This usually comes in buying mutual funds or ETFs with the same stocks or asset classes. This creates an overlap of investments and more complexity to manage. In addition, it doesn’t further diversify a portfolio by holding more funds if they hold similar investments.
Many investors will have a large-cap fund through fund company A and another large-cap fund through fund company B. These funds have exposure to the same part of the stock market and don’t add diversification benefits. So don’t own the same things wrapped in different packages.
As a long-term investor, you must keep long-term goals in mind and have a reason for your investments. There will always be short-term noise in the financial markets that cause investments to fluctuate in value. Short-term risk is the cost of admission to receive long-term returns.
Remember, TIME IN the market beats TIMING the market. The longer you invest, the higher probability of positive returns. In the graphic below, you can see the percentage of positive returns increases the longer you stay invested.
Mistakes can compound against you, just like compound returns work for you. Limiting big investing mistakes can increase your success (and cut down the time) to financial freedom. Stay tuned for part two of this blog series on big investing mistakes. If you find it challenging to manage your investments or need someone to stand between your money and the big mistake, let’s chat!
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