The Top 10 Investor Errors (And How You Can Overcome Them)
Have you ever checked out the finance section of your local bookstore? That’s usually the first place I zoom into, because I’m nerdy like that. The first thing you usually see is a SEA OF PURPLE in that hugeass shelf of Rich Dad, Poor Dad books. Don’t ask me why, but the gaudiness kind of turns me off. And then there are the shelves and shelves of books on awesome investment strategies: value investing, day-trading, swing-trading, volatility arbitrage, investing in wine/land/oil/Oompa-Loompa sex slaves..
For the amount of ink that’s been spilled to write about these sexy strategies, the hard truth is that 90% of investors will never be successful at any of them, because of their own inherent biases.
Barry Ritholtz wrote this great article on the Top 10 Investor Errors which I thought I’d share with you. If you’re just starting out in investing, or are thinking of doing so, I highly recommend that you read it – it’ll put you ahead most investors who don’t have a clue about the game that is being played around them.
The Top 10 Investor Errors:
1. High Fees Are A Drag on Returns
2. Reaching for Yield
3. You (and your Behavior) Are Your Own Worst Enemy
4. Mutual Fund vs ETFs
5. Asset Allocation Matters More than Stock Picking
6. Passive vs Active Management
7. Not Understanding the Long Cycle
8. Cognitive Errors
9. Confusing Past Performance With Future Potential
10. When Paying Fees, Get What You Pay For
At the risk of sounding like I’m under the influence of Error #8 (Cognitive errors – one of which is: “We selectively perceive what agrees with our preexisting expectations and ignore things that disagree with our existing beliefs.”), I’d like you to consider that a passive, low-cost, index-based, diversified and automatic (PLIDA) investment strategy will help you to overcome 9 out of 10 of these errors – pretty much everything except error #10 (because you don’t need to pay for a financial advisor). Check out my previous posts on investing if you need a quick refresher on a PLIDA strategy.
So how will PLIDA help you to be more baller than 90% of investors out there?
1. Investing in low-cost ETFs is – by definition – a low-cost strategy, which eliminates errors 1, 4 and 6. “Fees are an enormous drag on long-term performance… Typical mutual fund or adviser fees of 2 to 3 percent may not sound like a lot, but compound that over 30 or 40 years, and it adds up to an enormous sum of money.”
2. A diversified portfolio of index-tracking ETFs will take care of your asset allocation for you, eliminating errors 2, 5 and 7. When you’ve got a good mix of assets (say stocks, bonds, and real estate, diversified geographically), at least one of them will perform well at any given point, regardless of whether you’re in a bull or bear cycle.
3. An automatic investment strategy of dollar cost averaging, (investing the same amount of money at regular intervals while ignoring the price) will let you overcome the cognitive biases of trying to time the market, eliminating errors 3 ,8 and 9. Here, you don’t care about whether the stock market did well or whether the Fed is going to raise interest rates or what Ben Bernanke had for lunch today. You would calmly and surely stick to your strategy of investing, buying more when others are fearful (and prices are low) and less when others are greedy (and prices are high).
Meanwhile, back at the bookstore…
Go back to that finance section at the bookstore and try to find a book that’s written about PLIDA. Chances are, you won’t find that many. Not many people care to learn about the one strategy that offers them the highest chance of success. Instead, they prefer to bury themselves in their copy of Make Big Money And Retire Early By Investing With Covered Calls, and continue to delude themselves. How about you?