8 GREAT INVESTMENT MISTAKES

Eight Great Investment Mistakes in no particular order:

Overdiversification

Example: a person makes their 401(k) contributions annually and every year he (she) puts the new money into the top-performing equity fund on Forbes’s Honor Roll.  Twelve years later, this person owns a hodgepodge of 12 mutual funds, because-like Miss America-nobody wins twice.  This will result in an expensive index fund with gaps, redundancies and fee inefficiencies.

Underdiversification

The fatal narrowing of a portfolio down to essentially one idea.  Holding the preponderance of your equity “portfolio” in one stock is not investing.  It is Russian roulette.  Every day when the market opens, you point that gun at your head and pull the trigger in what economists call “creative destruction”.

 Euphoria

It is the complete loss of an adult sense of danger.  Your only concern is that somebody somewhere owns stocks that are going up more than yours.

 Panic

There is a consistent relationship between the height of the “mob’s” euphoria at the top of a big bull market and the depth of their panic-induced capitulation at the bottom of the concomitant bear market.  Panic is the pure essence of a loss of faith in the future.

 Leverage

This is when you borrow money, maybe against your home equity or on margin from a broker, to purchase an investment.  In practice, most people borrow at the wrong times and on the wrong terms, in order to buy the wrong things at the wrong times for all the wrong reasons.  The loan actually reduces the investment gain (if there is one) and increases the amount of the investment loss (if there is one).

Speculating When You Think You’re Investing

All short term trading is speculation, in that fundamental values do not change quickly.  An investor is always interested in long-term improvements in earnings, cash flows and dividends.  A trader is interested in quick changes in price, and is therefore always a speculator.

 Similarly, all options and all futures contracts are speculation rather than investments because their ending value after expiration is zero.

 Investing for Current Yield Instead of for Total Return

This is a mistake made by many American retirees.

 Investments which have the highest current yield (such as interest or dividends) have the lowest total return, while investments with lower current yield (such as interest or dividends)  must-in an efficient market-compensate by offering the higher long-term return.    The only rational test of an investor’s long-term income-producing potential is its long-term total return. 

 Letting Your Cost Basis Dictate Your Investment Decisions

Your cost in an investment has nothing to do with its objective value today.  Your investments do not know what you paid for them, and would not perform any differently if they did.

 One way this will show up is the refusal to migrate back toward proper diversification because one very successful investment would, were it sold, generate capital gains taxation.  This will then lead to Underdiversification since that successful investment becomes a greater percentage of the overall portfolio.

The other way this will show up is when an investor decides they cannot take the loss on an unsuccessful investment even though the fundamental have completely changed: indeed no objectively verifiable fact matters.

Note 1: Eight Great Investment Mistakes taken from the book “Behavioral Investment Counseling” by Nick Murray

 Note 2: Illustrations by Lauren E. Broderick and Sandra Glenn

Thomas L. Broderick, C. P. A. is the Treasurer of Pickens-Kane Moving & Storage Co. in Chicago, Illinois. He has served as Chairman of the Board of Trustees of the Illinois Movers’ and Warehousemen’s Risk Management Trust since 1996. He has also served as president of the West Central Association Chamber of Commerce for the years 2007 thru 2009. Many individuals, small businesses and non-profit organizations consult him for various accounting, investment, insurance and tax issues