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classic Investment mistakes |
There are several mistakes that most
investors make almost intuitively. I am so convinced of this that I am
tempted to go so far as to say that successful investors almost always
go against their instincts. Thus behavior modification or mistake
prevention is 50% of the road one must navigate properly in order to
arrive safely at their destination. (The other 50% is having a written
plan.) Here are some classic investor mistakes:
Panic and Euphoria.
These diametrically opposed concepts are commonly seen in the lives of
investors. Current events are almost always the culprit from which
these evil investment twins are born. The exacerbation of these events
by the news media contributes to the problem. Emotion can be a powerful
motivator to enable the accomplishment of many great endeavors.
However, emotion can also become a detriment to making clear-headed
decisions that should be made based on data and empirical evidence. We
have all made hasty decisions (in all aspects of our lives) that turned
sour because we made them while on an emotional high or low. This same
phenomenon can affect our judgment in the investment arena and,
furthermore, cost us a lot of money.
Speculating vs. Investing.
There is a difference. Most investors deem speculation the same as
investing. The American Heritage Dictionary defines investing
as “acquiring property for future income” and speculating as
“engaging in risky business transactions on the chance of great
profit.” On which would you rather stake your retirement claim? To be
more descriptive, picking individual stocks and timing the market are
speculating techniques. Buying into the miracle called capitalism via
broad and deep asset classes is called investing. Do not be fooled into
playing Wall Street’s speculation game – because rest assured – the
“house always wins.”
Bonds vs. Stocks.
Many investors – especially in turbulent stock markets - head to bonds
for “safety.” The wise Nick Murray explains that once one understands
the relationship between money and purchasing power, then it all falls
into place. What does that mean? Most investors that “go to bonds” are
trying to be “conservative.” In other words, they are trying to
conserve their money. However, the investment that conserves
purchasing power – not just principal – is the truly conservative
investment. You see, conserving purchasing power conserves principal
and future growth. Bonds do not do this - and never will. Only
stocks in the long run will accomplish this mission. Thus, stocks are
more conservative than bonds. I know this is a paradigm shift
for most, but it is an essential one for those that are serious about
being successful investors. (I might add that the next 20 to 30% drop
in a market are most likely to occur in the bond market – not the stock
market.)
Underdiversification.
One can get rich by underdiversifying, but one cannot stay rich.
This is easily exemplified with the tremendous amount of stock options
that were issued in the 1990s. We have friends and relatives that have
told horror stories of how huge their retirement plans grew, only to
plummet because so much was tied up in company stock. Individual
investors, including those already retired, are not immune from this
danger. I quite often see investors that have relied on only one or two
asset classes to grow their nest egg, only to see it dwindle when those
markets went through inevitable shifts. There is never a wrong time to
diversify properly. Get a properly drafted Investment Policy
Statement done today and proceed as expeditiously as possible.
Tax Moves.
Another classic. If your accountant is doing her job correctly, she is
doing everything within the limits of the tax code to reduce, eliminate,
or defer your income taxes. If your investment advisor is doing his
job, he is doing everything within his legal power to convince you to
avoid making investment mistakes. Unfortunately, sometimes the twain
shall meet – and it costs you money. Many times the proper investment
move is not made because of the adverse tax consequences that may be
present. Investors inevitably weigh the consequences of paying the tax
piper now vs. paying the unforeseen “value reduction tax” later. In
recent years, many have chosen to ignore the possibility of a stock
market reduction and have saved income taxes in the process. However,
the cost in lost value has far outweighed those taxes. One silver
lining for those in this boat is that now may be the perfect time to
redeploy your assets into a proper allocation for the long run, now that
the unrealized tax burden in your portfolio is not as great.
Conclusion.
While the bad news is that these mistakes are prevalent and will never
be eradicated – the good news is you can correct all of them now. What
a great thing to have that kind of empowerment! The key is sitting down
with a qualified advisor and creating a plan of action – we call this an
Investment Policy Statement. Once this plan is finished, then
the correcting of these mistakes can take place at once. We are big
proponents of using asset class funds that we feel provide the
broadest and deepest diversification in the universe. They are also
generally less expensive than retail funds and are used by institutions
such as pension plans and scholarship funds for long-term investment
success. So avoid those classic mistakes and keep those emotions in
check. Invest – don’t speculate. Have faith in capitalism and its
potential. Don’t let the tax man dominate your investment decisions.
All this will add up to long-term investment success!
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