My last few posts outlined Barry Ritholtz’s 10
investor mistakes and Robert Seawright’s 10
Most Common Behavioral Biases.
I gave a brief description and then provided a solution to avoiding such
errors. Today I cover some errors not
mentioned by the last two authors.
- Political Trades – an investor makes an investment or trade based on his or her own political views or that of a commentator. Solution: Avoid these investments all together. An easy way to spot one is the association of a political party or politician to reason why investment ABC will move up or down. That isn’t to say geopolitical events don’t move markets, they do. But look for analysis with data, not vague political diatribes.
- All or None – this is similar to Rithotlz’s #3 (being your own worst enemy), but often times investors will get bullish and want to move all into stocks and/or bearish and move all into cash. Such large moves can drastically increase the chances of being right or wrong and alter the longer-term risk/reward profile of the portfolio. Solution: Have a game plan. Make moves in ranges, particularly on the downside. If you get nervous, take a % away from equities and move into bonds, but try not to alter your whole portfolio. Even better, have a plan on the way down with different sell points, hedged investments, moving up in quality, stop losses, etc.
- Ignoring Liquidity – not realizing the importance of having your capital locked up in investments that don’t trade daily. Solution: Not all illiquid investments are bad, but make sure you realize that your assets will be tied up and for how long. A hedge fund probably has greater liquidity than CRE, but both will have capital tie ups, for example. Further, make sure you know the underlying investments, as this has bearing on the nature of the liquidity. In the last downturn, some of these investments, which were supposed to provide quarterly liquidity couldn’t perform due to the nature of their holdings.
- Investing in What You Don’t Understand – deploying capital to investments (now investments with a higher yield are all the rage) that are confusing and/or complicated to the investors. Solution: Don’t get it? Don’t buy it. If you can’t answer the questions how much risk am I taking for the return and what the investment does to produce said returns, then chances are the investment isn’t for you. It doesn’t make the investment bad, but it just increases your risk that it won’t perform as expected in any number of economic scenarios. A rule of thumb - the more complicated the higher the seller compensation, so watch the soft costs, they dig deeply into return.
- Ambiguous to Time Horizon – investing in inappropriate asset classes based on time horizon. Need money in a year? Don’t invest in stocks. Solution: Figure out what you need from your savings and investments over the next few years and earmark assets for those purchases. A lack of liquidity can also be measured by selling your assets at a loss when you need the cash. Making sure your time horizon matches your asset mix can help alleviate that issue.
