I'm back today to break down the 20 most common investment mistakes as outlined by the CFA Institute. This emphasizes the importance of planning ahead, minimizing emotional decisions, considering risk tolerance, and the importance of partnering with a financial professional.
The CFA Institute is a professional organization of Chartered Financial Analysts, and they specialize in investment management and portfolio management, basically wealth management. A lot of times CFA holders will work for money management firms or big Wall Street firms, stuff like that.
They put out this list that's pretty comprehensive, so I want to go over it and give you a little bit of my take on some of it, and some of them overlap as well too.
1. Expecting too much: A lot of times you want to be able to frame investment expectations properly. Some people might have really high expectations. Investors actually have an annual expectation of a 15.6% return. That's really high over time! While financial professionals actually expect closer to a 7%. That seems way more realistic to me, obviously. I'm a financial professional, right?
Over time I know the S&P 500 has actually done over 11% per year for like the past 100 years, which is fabulous, but a lot of times most people's returns are different than that for whatever reason. Most of the time maybe they don't need that, maybe they're trying to time the market, maybe they've invested in the wrong things, or a combination thereof, but framing expectations is very important. We spend a lot of time doing that.
I would be much more comfortable with the 7% going forward, at least planning for that, and then we could always make adjustments if things go better or also worse.
2. No investment goals: What we try to frame at my firm is let's say, and this actually happened recently, let's say we have a couple that comes in and they've got $4 and a half to $5 million, and they say I need $200,000 per year to live on for the next 30 years of our lives and that'll be great, we'll be in great shape,
Okay, perfect. But then they say we think if we do this, this, and this over the next 3 or 4 years, we might double that. We might have $9 to $10 million. Okay, well that's a different goal, and if you only need $200,000 a year, your $5 million portfolio is already well enough and good enough for you to live the way you want. Why take that risk of it going to $2 million, and then you won't be able to live the way you want. So proper framing of goals is of course always very important.
3. Not diversifying: You might have heard this before, but diversification is basically the only free lunch on Wall Street. Diversify not only to make sure that you don't have single stock risk but also a lot of times the best returns in an index like an S&P 500 Index come from only a handful of companies, and the odds of you picking that company over time are very rare. It's okay to lean one way or another for certain reasons; usually statistically is better than any gut feeling you have.
4. Focusing on the short term: Now obviously people that focus on the short term, day traders, what have you. They're going to have higher transaction fees, and they're probably going to make more mistakes because they're trying to focus on stuff in the short term, something they may have had an opinion on or a thought on and then in the short run it didn't do well but over the longer term, maybe they sell out before it gets time to play out, and then over the long run what they thought was going to happen happened, but they've already sold out so they missed out on that.
5. Buying high and selling low: We want to do the opposite, right? We want to buy low and sell high, but again this is kind of goes along the lines of trying to time the market right.
If I were to ask you what are some of the best investment people that you've heard of throughout history, you'd probably say Warren Buffett, Peter Lynch, so on and so forth. Maybe David Tepper if you pay close attention to hedge funds.
But if I were to say, who are the best market timers in history, nobody ever has an answer for that. Well, there's a reason right. Even if you time really well when to sell one time, when do you get back in? So you've got to be right twice there.
Then let's say you happen to get both of those right once. Well, then going forward how do you time it again, and people think they can and they never can, and so it never works out and then statistically your returns are going to be 2% less than if you had just bought and held
6. Trading too much: We kind of already covered this with focusing on the short term. 6.5% is typical average under investment for someone that trades way more than someone that just buys and holds for the long term. So trading too much is definitely a big one.
7. Paying too much in fees: You always want to be cognizant of fees. Statistically over time, even the best mutual funds over a 10 or 20 year period: Alpha - the percent that they beat the market or whatever index they're going against gets eaten up by fees. Plus it's just really hard to do, so we like to get the best investments to meet someone's goals at the lowest possible cost.
8. Focusing too much on taxes: Now this is more talking about like tax loss harvesting and tax gain harvesting, which you know you want to pay attention to. We do a lot of tax planning at my firm. That is a little bit different.
What this is talking about this is as it pertains to investments, and we definitely focus on tax loss harvesting. We have that as an arrow in our quiver, but we don't want to let the proverbial tail wag the dog as far as taxes go. And again with tax loss harvesting you've already lost money, so it might be more of a Band-Aid, and what you need is more of a tourniquet or to set the cast.
9. Not reviewing regularly: This is typically not a problem with my clients. They typically have a pretty good idea what's going on with their investments, at least where they're at. They might not know why, but they know where they're at. If you have any questions feel free to reach out but you want to keep an eye on it but don't want to pay too close attention.
10. Misunderstanding risk: We like to frame our investments with guard rails, so basically we're staying in a certain zone, and certainly once we start taking withdrawals from a nest egg, we want to have a plan in place so that when and if the market does come down, we have something planned. We're not shooting from the hip. And we want to put guard rails on that situation, and we want to have it framed.
11. Not knowing your performance: Again this isn't really a problem for our clients. We talk about it but as long as we have enough going in the right direction for us that we are able to meet our client goals then we tell them not to even focus so much on performance. We'll handle that, and we'll definitely keep up with the rising cost of retirement, which is the goal when we get to retirement. We need to think about return of investment as much as return on investment.
12. Reacting to the media: Now this is a big one. Negative news which of course is what sells the most in media is what people often get sucked into I guess we could say if they watch too much CNBC or other programs like that, Fox Business, whatever it might be.
Over time, three out of four years the stock market actually goes up, and yes the problem is you know nobody likes to see their money go down. Typically we're climbing a wall of worry when the market goes up, and then it takes the elevator down, and that's what people always freak out about. Nobody likes to see their money go down, but typically staying the course is the best course of action.
Of all these other things that I've mentioned - if people are day trading or trying to time the market, statistically they're performing 3 or 4% under the market every year because they're trying to take advantage of stuff that they can't control, nor can they time properly.
13. Forgetting about inflation: We always want to be cognizant of inflation, but again, what we try to do is make sure that we're diversified enough that we're keeping up with the rising cost of retirement.
14. Trying to time the market: We already discussed this one quite a bit. There's a lot of studies done where people might own a mutual fund. Let's say they've only been invested in one mutual fund over the course of 5 years, but they've underperformed that fund by 20 or 30% because they were trying to buy and sell in and out of that fund or ETF, and they did it at the exact wrong times, which is typically what human nature leads to.
15. Not doing due diligence: You definitely always want to do your due diligence. I think that's pretty easy these days with people having search engines and the internet to really quickly do your due diligence, but you definitely want to do that.
16. Working with the wrong advisor: Now obviously investment management is very important, but again, you want to focus on return of your investment as much as return on it, and what we always like to do too is lay the tax code on top of that. Because if you're going to have 20% returns every year, but you have to give 10% of that away in taxes, and our tax code is set up to siphon money from that account, make sure you're working with someone that pays attention to that so you want to work with a preferably a CFP® tax planning adviser and a fiduciary.
17. Investing with emotions: This typically leads to investors underperforming the markets by 3% per year because of emotionally-driven investment decisions. So you definitely want to avoid that. This kind of overlaps with some of the other stuff that we've already discussed.
18. Chasing yield: Sometimes people will come and be like, hey Tim, this stock has a 10% dividend or this bond is at 10%. Well, the reason for that is because there's typically something wrong with that particular bond or corporation, and it's going to get cut, so it's going to go from 10% to maybe 2 or 3% to maybe no dividend at all. So we definitely want to know the whole financial situation before you're going to put your money into it.
19. Neglecting to start: Or basically neglecting the power of compound interest. Compound interest is very powerful over time. As a little example, you would have $1.2 million at the end of your portfolio value if you invested $15 a day for 50 years and had a 7% annual compound return. That is the power of compound interest.
20. Control what we can control: Now I say this all the time. I try to do it in my own life with everything. There's only so much we can control. We can't control what the market does, but we can control what we're going to do and what levers or thresholds we're going to flip or push up to in the meantime taxwise, or even how we're going to maybe shuffle some investments around if and when certain things happen. So we always want to focus on things we can control because there's always enough stuff out there that we can't.
I try to do that a lot in my personal life. Sometimes people might even in my personal life get sick of me saying it, but it is something that we all need to focus on as much as we can.
So with that, I just want to say this is a good list. Everybody has their own things, but if anybody would like to discuss further, please reach out.