12 Common Mistakes Investors Make

  1. No Investment Strategy
    • Every investor should start with an investment strategy that serves as a framework to guide future decisions
    • A well-planned strategy takes into account several important factors — time horizon, tolerance for risk, amount of investable assets, planned future contributions, etc.
  2. Investing in Individual Stocks Instead of in a Diversified Portfolio of Securities
    • Investing in 1 or a few individual stocks increases your risk
    • Investors should maintain a broadly diversified portfolio incorporating different asset classes and investment styles
    • Failing to diversify leaves individuals vulnerable to fluctuations in a particular security or sector
    • It is also possible to over-diversify and own too many investment products, particularly if an investor has a modest portfolio — this unfocused approach will generate higher overall fees and is less strategic
    • The best course of action is to seek a delicate balance — often, this can best be done with the advice of a professional or trusted advisor
  3. Investing in Stocks Instead of in Companies
    • Investing is not gambling and shouldn’t be treated as a hit-or-miss proposition
    • When you invest, you assume a reasonable amount of risk to help finance enterprises you believe have positive long-term growth potential
    • Before buying a stock, analyze the fundamentals of the company and industry, and make sure it has basic corporate governance protections
    • Don’t look at day-to-day shifts in stock price — buying a particular stock because it looks like it’s going up or because you like a company’s product or service is not a sound investment strategy
  4. Buying High
    • The fundamental principle of investing is buy low and sell high
    • 2 main reasons investors end up doing the opposite are:
      1. Performance chasing and following investment fads — just because a stock, fund or industry has done well in the past is no indication of future performance
      2. Buying a popular stock often leads to investing at the height of a cycle or trend — just in time to ride it downward
    • Investors often end up buying high and selling low because they think short term instead of maintaining focus on their long term investment strategy; this isn’t strategic
    • Investors shouldn’t draw conclusions from the past but should always look critically at the prospects for future performance
  5. Selling Low
    • When a stock goes down, too many investors are slow to cut their losses and sell — they hold on hoping to regain at least some of what they have lost
    • Not every investment will increase in value and even professional investors have difficulty beating the S&P 500 index in a given year
    • Always have a stop-loss order on a stock as it’s better to take the loss and redeploy the assets toward a more promising investment
  6. Churning Your Investments
    • Frequent trading cuts into investment returns more than anything else
    • A study by two professors at the University of California at Davis examined the stock portfolios of 64,615 individual investors at a large discount brokerage firm between 1991 and 1996
    • The study found that, without transaction costs, these investors received a 17.7% annualized return, which was 0.6% per year better than the stock market itself

    • But, after transaction costs were included, investors’ returns dropped to 15.3% per year, or 1.8% per year below the market
      • The solution is a long-term buy-and-hold strategy, rather than an active trading approach
  7. Acting on “Tips” and “Soundbites”
    • Always keep in mind that you are investing against professionals who have access to teams of research analysts
    • Too many investors use the media as their sole source of investment thinking instead of pursuing a professional relationship with an advisor
    • Seasoned investors gather information from several independent sources and conduct their own proprietary research and analysis before making an investment decision
    • Just because information is new to you doesn’t mean it’s really new — if you’ve heard it, so have many others (this information, therefore, is already factored into the market price)
  8. Paying Too Much in Fees and Commissions
    • It’s difficult to cite specifics on the fee structure employed by investment service providers — i.e., management fees and transactions costs
    • Before opening an account, investors should make sure they are fully informed about the expenses associated with every potential investment decision
    • To gauge your overall performance, adjust all your investment returns for fees and expenses paid
  9. Decision-Making by Tax Avoidance
    • The first objective should always be to make the fundamentally sound investment decision
    • To avoid capital gains tax, many investors will allow the value of shares in a well-performing stock to grow to account for an inordinate percentage of their overall portfolio
    • Similarly, don’t hold on to a security past the 1-year purchase date simply to take advantage of a lower capital gains rate
    • If you are concerned about tax, find a good tax advisor — don’t let it change your investment decisions
  10. Unrealistic Expectations
    • Expecting returns of 20–25% annually will result in disappointment or excessive risk-taking
    • According to Ibbotson Associates, the compound annual return on common stocks from 1926–2001 was 10.7%, but only 4.7% after taxes and inflation
    • Returns on long-term bonds over the same time period were 0.6% after taxes and inflation
    • It is important to take a long-term view of investing and not allow external factors to cloud actions and cause you to make a sudden and significant change in strategy
  11. Neglect
    • Many fail to begin an investment program because they lack basic knowledge of where or how to start
    • Likewise, periods of inactivity are often the result of discouragement over previous investment losses or negative growth in the equities markets
    • To be certain, investors should continue investing in every market — albeit through different investment vehicles — as well as establish a mechanism to make regular contributions to their portfolios
    • Investors should also regularly review their holdings to ensure they are adhering to their overall strategy
  12. Not Knowing Your Real Tolerance for Risk
    • Determining your appetite for risk involves measuring the potential impact of a real dollar loss of assets on both your portfolio and psyche
    • You should be realistic and evaluate your level of risk tolerance and invest accordingly
    • Generally, individuals planning for long-term goals should be willing to assume more risk in exchange for the possibility of greater rewards
Content adapted from CFA Institute

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