Recently there has been a wave of good articles outlining
investor mistakes. As a result I thought
I would outline the two pieces I read and then in a separate post, add my own.
The first piece is from Barry Ritholtz entitled “Investors’
10 most common mistakes”. I present
my Ritholtz’s mistakes and then suggest a solution:
- High fees – over time fees can be a big drag on returns. Solution: Seek out investment managers with lower fees, ask for transparency, and avoid complicated investments with higher fees.
- Reaching for yield – picking investments based on what they kick out in income. Solution: Always keep an eye on the risk vs. return trade off. This has been a common and BIG mistake by many investors in the last five years investing in CDO’s and like securities. On the equity side look for quality, not yield.
- Your own worst enemy – making investment decisions based on emotion. Solution: I like Mr. Ritholtz’s solution, if you need to “feed the beast” do so with a small amount of capital so as not to sabotage your portfolio.
- Mutual funds vs. ETFs – mutual funds charge higher fees than ETFs. Solution: Be diligent in your active management selection and use ETFs as a foundation in your portfolio. Anywhere from 15 to 30% of active managers have outperformed the indexes, depending on the asset class.
- Asset allocation vs. stock picking – how you allocate to asset classes matters more than security selection. Solution: Give a greater weight to what asset classes you are in, paying particular attention to risky assets and realizing in times of crisis or euphoria they move together making security selection inconsequential.
- Passive vs. active – most active managers struggle to beat the passive benchmark given fees. Solution: Similar to #4. Again, thoroughly comb through active managers, know their strategy, be aware of fees, check their performance, and, most importantly, make sure qualitative factors are in place for repeatable success. DON’T CHASE RETURNS!
- Not understating the long cycle – markets move in secular cycles. Solution: Be cognizant of what is going on currently; however, never lose sight of the secular trend. Realize strategies that work in bull cycles won’t necessarily work in bear cycles and vice versa. Additionally, realize that bull market runs exist in secular bear markets and vice versa.
- Cognitive errors – we suffer from many cognitive deficiencies which can present themselves when we invest. Solution: Too much to cover in a couple of sentences. I will expound on behavioral mistakes more in my next post.
- Past performance and future returns – chasing the hot money and not taking into account qualitative factors. Solution: Know the managers you are investing in and whether the past performance is replicable, luck, or more on beta (asset class performance) than alpha (security performance). Don’t chase purely based on performance!
- Get what you pay for – paying for advice or services you can DIY and/or finding the right people. Solution: Seek credible trustworthy referral sources. Interview several advisors and determine what you get for what you pay. Most importantly make sure it feels like you can develop the chemistry required for a successful relationship.
Up next, various
cognitive errors we make.
