10 Ways You’re Sabotaging Your Investing
Statistically speaking, investing isn’t likely going to make you many times richer very soon but it’s also not likely to leave you in the poor house if you keep it up in the long run and heed the 10 common pitfalls I’ve outlined below.
1. You’re not investing money you can’t afford to lose in the short term.
(Corollary): You’re too scared to invest at all.
Investing is inherently risky and there are no guarantees especially in the short term. Even a moderately low risk index or mutual fund can typically lose more than 1% in a single bad trading day. But investing, if kept up properly over decades, is very likely to yield returns that exceed those on cash and beat the inflation rate.
One of the most common (but understandable) excuses not to invest is that you’re afraid of losing money. But the money you keep under your mattress will lose an average of 3% every year due to inflation. Even the interest paid on savings accounts in the long run doesn’t exceed inflation except in maybe a handful of years, at least in the US. If you’re still not convinced, then visualize yourself hoarding your cash under the mattress for the next 25 years. If inflation continues growing at its historical average of 3%, then that money will have lost about half of its purchasing power then. You’re now an old woman or man and your precious stash under your mattress can only buy about half as much as it’s capable of today. Do want to end up like that? If not, then you’ll need to learn the basics of proper investing (which I will go over in further detail in future posts)!
On the flip-side, I’m not saying you should never have any cash lying around and be fully invested all the time instead. But money that isn’t essential to keeping a roof over your head, your family fed, and other regular recurring expenses paid, etc. is probably better used in the long run being invested.
2. You’re taking more risk than you’re emotionally capable of accepting.
If you want your investments to return more, then you got to take more risks. This principle has been true for many millennia in the past and will likely be true for countless millennia in the future as well. How do you know you’re taking too much risk? Take a look at the investment or the combination of investments in your portfolio and research its worst performing year in the last few decades. Now imagine it losing TWICE as much as its worst year. Don’t just gloss over visualizing it losing that much money, do a pre-mortem and imagine yourself logging into your brokerage account or receiving the statement in the mail and opening it to find the terrible loss. Are you able to stomach that loss? If no, then redo the pre-mortem exercise with investing a smaller portion of your wealth and being hit with the same percentage loss; keep reiterating with a smaller portion until you feel comfortable with the loss.
Also, don’t discount the non-financial and non-monetary costs of overinvesting in risky assets as well. Read this classic article written by Tim Ferris back during 2008 crisis. To quote him:
If you have the potential to make 30% per annum in a given stock, but it keeps you up with sweaty palms at night, is that a good “investment”?
In other words, don’t underestimate the tolls on your mental health and any further spillover effect on other areas of your life (family, work, hobbies, etc.) due to the constant anxiety you have to endure by taking too much risk.
3. You listen too much (or too little) to Financial News and other pundits.
Do you watch CNBC or Bloomberg TV or read the financial news every single day? Then you need to cut back because the main objective of the reporters isn’t to keep you informed of the most important happenings in the markets but to keep you glued to the news they’re offering. Telling people that the markets are gonna crash or skyrocket retains viewers. On most days, the stock market and economy is humming along at a boring pace anyways but saying that doesn’t lure in new viewers easily.
On the other hand, don’t cut yourself off from the news entirely either especially if you invest in individual stocks (which I don’t recommend btw but is the route most people take.) Try reading the Business/Finance section of your local newspaper rather than CNBC, Bloomberg, NY Times, LA Times, Chicago Tribune, etc. Or head over to SeekingAlpha where professionals provide their insight and analysis rather than entertainment as their main agenda.
4. You pick stocks.
Almost everyone does this when starting out (myself included.) We’re constantly bombarded by stock charts in the financial news and even movies like Wall Street. You’ve probably heard of the saying not to put all of your eggs in one basket so you’ll own several different stocks which is a good start. But in order to diversify away the company-specific risk, you need at least 10 different stocks, preferably 20+. Can you honestly pick 10-20 good companies from different sectors of the economy?
The good news is much of the hard work of diversification has already been done for you. Index funds, especially in the form of ETFs, package tens or hundreds of different stocks into a single entity which diversifies away the company specific risk. These indices are constructed by professionals who have years of experience with investing and risk management. Since the expense ratios on many of these funds are quite low (well under 1% a year), they can be very lucrative for new and even veteran investors who do not have decades of experience picking stocks.
5. You trade frequently.
Even with trading commissions in the single digits at most brokers these days, trading frequently can get expensive. These costs include not only commissions but also short-term capital gains taxes, exchange fees, bid-ask spreads, etc. Besides, if you have a well researched investment strategy that will perform reasonably in virtually all economic environments (more on this in future posts), then there’s no need to constantly second guess yourself day to day.
Every time you trade, you’re making a decision that’ll affect the fate of your own money. If your money is at stake all the time (from frequent trading), then you’ll likely have a ton of anxiety. Is wrecking your mental health and the spillover effect on other parts of your life worth the money? Keep in mind that passive investors have been making slow but steady progress in their investment accounts over the decades so frequent trading is not even necessary in the first place!
Try looking at your investments less frequently and you’ll likely trade less. Can’t stop looking at your investments? Then you’re likely taking too much risk!
6. You delegate responsibility to an advisor.
Nobody cares about your money more than you do. No, contrary others want you to believe, most financial advisors are not scam artists. They are generally faithful to their fiduciary duty to look after your money and assets. But they’re human just like the rest of us, except they’re likely managing money for tens or even hundreds of clients simultaneously and are not allowed to give preferential treatment to you or any other client. And when a downturn hits, these folks are likely to be swamped by angry and anxious clients while trying to save their own assets (no pun intended.)
I’m not against the idea of getting a financial advisor provided that you continue to learn about finance and investing on your own instead of delegating everything to the advisor. In fact, I think it’s a great idea as a beginner to get a second opinion and more detailed advice that’s specific to your own situation (especially when it comes to taxes and estate planning.) But always be wary whenever you’re being presented specific investment vehicles by the advisor (such as mutual funds.) ALWAYS ask them what incentive they receive from you picking that particular investment! If the advisor refuses to answer, gets uneasy, and/or even drops you as a client, then this wasn’t the right advisor for you in the first place!
Also, here’s a situation many advisors face periodically where they are forced to choose between investing in your best interests and potentially being sued. In less than favorable market circumstances like corrections and bear markets, the portfolio has the best chance of performing better if the advisor left it alone than if he/she took action and sold the losing investments, but this not 100% guaranteed. Let’s say a particularly rough market downturn is underway and doing nothing has a 7 out of 10 chance of performing better than selling. It would be in the client’s best interest to do nothing, right? Now suppose they lucked out and the investment continued to drop despite only a 30% probability of happening. Under the current laws and regulations, the advisor stands a fair chance of being sued and possibly losing his/her practice for taking NO action. Most advisors understand their potential fate if they luck out from doing nothing and end up taking action for the client as a result even though they’re fully aware probabilistically not in the client’s best interest.
I don’t blame the advisors for their actions in such circumstances either. It’s just the legal system (and human nature) putting a severe penalty if not taking any action is followed up by a bad outcome even if no action is the wisest thing to do without knowing the future. A similar situation also exists in medicine as well (read all about Iatrogenesis if you’re curious.)
7. You’re only invested in ONE asset class.
And chances are, the one asset class is stocks. Like I mentioned in #4, the media and pop culture pushes us to equate investing with buying stocks. But there are plenty of other asset classes out there including bonds, real estate, metals, etc. If you’ve ever tried picking stocks, you may have noticed that there’s some limitation to the diversification that they provide, especially on a day when the stock market loses big time. The one stock in your portfolio that you thought was a sure thing and has had the biggest return since probably didn’t escape the wrath and carnage of the market. Most stocks, whether they’re “good” or “bad”, will at least exhibit some correlation with the broad market (e.g. S&P500.)
At a minimum, I recommend that each portfolio contains at least 2 asset classes: stocks and government (not corporate) bonds. You may have heard about the negative correlation between stocks and bonds but it doesn’t absolutely hold. Still, it’s better than putting all of your eggs in one asset class. (I’ll likely write a separate post exploring this process, asset allocation, in detail in a future post.)
8. You pay too much (or too little) attention to Black Swan events like 2008, 1974, the Great Depression, etc.
Extreme events tend to occur far more than is predicted by a normal distribution, especially on the downside (like in 2008) but also on the upside as well (like in 2000.) Nassim Taleb coins these phenomenon Black Swans which has recently found its way into colloquial language after the 2008 crisis. These events, by definition, are rare and shouldn’t deter you from investing in the long term provided that you are not overly exposed to them. Picking a conservative asset allocation in multiple asset classes (see #7) is a step in the right direction to mitigating Black Swans.
On the other hand, don’t underestimate the probability of adverse Black Swans either. This is especially evident in certain stocks and even indices that seem to be in a long-term uptrend with no major downturn for years. (Whether you’re reading this in 2015 or 20 years from now, there’s almost always a stock, commodity, index, etc. that’s constantly in the spotlight for this behavior.) More and more investors get “sucked” in chasing the seemingly unstoppable uptrend. When investors exit due to a little bit of negative news, they exit en masse and the price plunges. This was how the collapse of various bubbles played out including the 2000 Internet bubble, the 2007-2008 oil and real estate bubbles, the 2011 gold bubble, etc. It’s OK to speculate on the continuation of a trend with money you can afford to lose but putting a massive % of your wealth in pursuit of such trends is just asking for trouble.
9 .You hate Wall Street and other institutions in general.
This is one of the more ridiculous excuses but I’ve heard it uttered countless times, especially by fellow Millennials. Well over half of all American households owns stocks, either directly or indirectly through an index or mutual fund. Sure, the rich (top 5%) may own a larger share of the wealth in the stock market but the vast majority is held by the masses of middle class folks. Wall Street and investment firms do take a relatively negligible cut from the gains from your investing in the form of commissions and fees (as long as you pick no-load mutual funds or ETFs with low fees.) But you’re missing out on years of compound interest (that you’re never getting back) from your money working in your sleep if you choose not to invest! Even if you choose to keep all of your money in a bank, the bank will continue to loan it out and earn interest from it. And keeping your money under your mattress is basically giving an interest-free loan to the government. So if you’re against the idea of institutions benefiting from your money, even in negligible ways, then you might as well burn it all and live off of the grid!
10 . You’re waiting for the perfect opportunity.
I’ve got news for you: nobody can accurately predict the future. Skilled analysts and economists might have a more accurate picture of what the future holds but nobody can predict it with 100% accuracy. Statistically speaking, the markets are more likely to go up than down over the long run (otherwise, nobody would bother to invest) and waiting for the right opportunity will likely cost you the gains you would have otherwise made.
No, I’m not saying you should call or log in to your broker and haphazardly buy some random stocks and call it a day. But while economists may proclaim that the market is overvalued or undervalued, nobody knows for sure except in hindsight. But if you can’t bear the thought of buying an overvalued market that you believe will be coming down soon, then buy a little bit anyways and keep buying once the market falls and you’re proven right. (Or if the market never falls, at least you have some gains to speak of.)
If you’re completely new to investing, this article won’t have all the answers you need to be a successful investor. But don’t let this deter you from this endeavor! If you don’t understand any of the jargon I’ve used in this article, please head over to Investopedia. I’ll also expand on several of the points I’ve made here in future posts, so please Subscribe to the Newsletter. If you’re dying to get a head start, I recommend taking a look at the following resources in the meantime:
- 50 Unfortunate Truths About Investing.
- Harry Browne’s 16 Rules of Financial Safety.
- Bogleheads (this is a community of fans of John Bogle, the father of Passive Investing and the former CEO of Vanguard.)
- What I Learned Losing a Million Dollars
Do you have any other barriers or excuses for not investing? Or would you like me to elaborate any of the points above in further detail in a future post? Please share them in the comments below!