Years ago, a veteran advisor made the observation: “All clients think they are aggressive investors in a rising market.” They think making money is easy. When the stock market changes direction, they are slow to adapt. What mistakes do they make?
1. Not opening their statements.
It doesn’t matter if they arrive by mail or can be accessed online, these investors ignore them. They do not want to be upset, so they rationalize if they don’t look, they haven’t really lost any money. Advisors make this mistake too. Not wanting to be the bearers of bad news, they reduce the frequency of contact with some clients. They believe: Let sleeping dogs lie.”
Problem: In both cases, two back to back losing months means the damage is even worse. You need top face up to the situation. Is there anyway you can take action?
2. Reacting, not acting.
Veteran investors take the long-term view: What are the long term trends in place? Do I own quality companies positioned to take advantage of these trends? Should I buy on weakness? Other investors agonize over what the stock market might do tomorrow. Should I stay or should I go?
Problem: They obsess over the short term, which is notoriously unpredictable.
3. Misunderstanding margin.
They bought into the leverage argument, making money using other people’s money. Financial services firms make this very easy, partly because the collateral, listed securities, is so liquid. They do not understand when stocks go down, the loss is all borne by the investor. The loan stays the same size or grows larger.
Problem: Like a sailboat in a storm, you need to bring down the sails. Make yourself as small a target as possible. If you are overextended, you can get a margin call at the worst possible time.
4. Keeping short term money in long term investments.
You have a college tuition bill that must be paid in September. The funds to cover the bill are invested in the stock market, which is going through a rough time. You are sitting tight, absorbing the losses because you hope the situation will turn itself around in the next three weeks.
Problem: Money that is needed in the short term should be kept in short term instruments like money funds. You do not want to sell stocks on a bad day.
5. Holding your losers, selling your winners.
People have said: “No one ever went broke taking a profit.” They might have, if they held their losers and rose them down. The opposite logic should be followed: Keep riding your winners up and sell your losers early.
Problem: They do not realize a stock that declines 33% needs to rise 50% before you are even.
6. Not understanding diversification.
Everyone agrees you should not put all your eggs in one basket. Some investors own several stocks, but they are all in the same industry. Others own several mutual fund, but the top five holdings are the same stocks in every fund.
Problem: Some sectors outperform others. Often it’s not apparent until after the move has begun.
7. Ignoring advice.
James Bond movies have taught us when something bad happens, there is an evil supervillain involved. Nothing is your fault because someone else is to blame. The lawyer ads on TV support this argument. These investors ignore their advisors in bad times because they feel the advisor got them into this difficult situation.
Problem: Many advisors are experienced. They might be on teams. They have strategists and analysts working in the background. Your advisor wants you to make money. Give them a chance to try to help.
It’s often been pointed out the average growth mutual fund returns more over time than the average holder of the mutual fund. That’s because many investors think short term and second guess advice.