There are only two paths to gaining the experience necessary to know how to minimize investment mistakes:
- Smart Path: by learning from other people’s investment mistakes
- Expensive Path: by making your own investment mistakes and learning from the school of hard knocks
Learning vicariously helps you avoid losses, which leaves more profits in your pocket and accelerates your journey to financial freedom. For that reason, let’s look at the top twelve investment mistakes gleaned from years of coaching experience so you don’t have to pay the price of direct experience.
Investment Mistake Tip #1: Diversify The RIGHT Way
Diversification is a valuable risk management tool, but only when used properly. Diversification only adds value when the new asset added has a different risk profile. To diversify the wrong way is to add more assets with a similar risk profile until your investment performance replicates the averages. Your goal when diversifying should be to add independent and sometimes opposing sources of return. This can lower portfolio risk and possibly increase overall return when coupled with other investment techniques explained below.
Investment Mistake Tip #2: Don’t Pick Stocks – Asset Allocation Is More Important
Multiple research studies agree that at least 90% of the variance in a diversified portfolio’s returns is attributable to asset allocation. What’s surprising, however, is that most people mistakenly focus 90% of their efforts on the remaining 10% of return by trying to pick individual securities. It makes no sense.
Investment Mistake Tip #3: Don’t Confuse Historical Returns with Future Expectations
Just because your investment advisor told you the average historical returns from the stock market are approximately 10% annually don’t mean you should expect similar. The future will likely be very different from historical averages, and your average holding period may not be long enough to replicate average returns.
Investment Mistake Tip #4: Don’t Invest Without a Plan
Don’t make the mistake of spending more time planning your vacation than planning your financial future. Numerous studies show that people who are methodical enough to create a written investment plan can expect to outperform their peers, not by just a few percentage points, but by multiples. You must create a disciplined plan based on mathematical expectancy because anything less is gambling and not investing.
Investment Mistake Tip #5: Don’t Forget to Invest in Your Financial Education
You must learn before you can earn. Every investment you make in yourself will pay you dividends for a lifetime. Investing done right is both an art and a science. For that reason, you must be wary of half-truths and oversimplification that don’t respect the inherent complication of the process.
Investment Mistake Tip #6: Don’t Forget to Match Investment Style with Personal Goals
Don’t make the mistake of climbing the ladder to investment success only to discover it’s leaning against the wrong wall. There’s no single right answer to investment strategy that will result in financial success for everyone, but there’s one right answer that will be true for you.
Investment Mistake Tip #7: Don’t Place Excessive Trust in “Experts”
Everybody has a conflict of interest with your wealth except you. Investment institutions manage your money so they can charge fees, and financial advisors sell you products so they can earn commissions. Similarly, the investment media seeks to maximize subscription and advertising revenue thus biasing editorial policy toward “sizzle” that sells rather than substance that serves.
Investment Mistake Tip #8: Beware of Low Liquidity
A liquid investment is something that can readily be converted into cash, and an illiquid investment is something with barriers that keep it from being converted to cash. Never make the mistake of accepting low liquidity unless the potential reward is so great as to merit the additional risk.
Investment Mistake Tip #9: Beware of Excessive Conservatism or Risk Taking
The essence of the investment game is balancing risk with reward, and the better you get at risk management, the more reward you can pursue. You should invest aggressively when the reward merits the risk, and conserve capital by hiding in the safe harbor of cash equivalents when risk is excessive.
Investment Mistake Tip #10: Don’t Confuse Brains with a Bull Market
A rising tide lifts all boats. When the tide goes out is when you see who is standing naked in the water. Don’t mistake brains with a bull market just because you happen to be in the right place at the right time and made some good money through sheer luck.
Investment Mistake Tip #11: Don’t Confuse Total Return with Value Added
When measuring investment results, don’t make the mistake of looking solely at how much money you made. The reason is because total return is a composite of market return, style return, and management skill. Looking at total return without separating the source of the return will cause false conclusions.
Investment Mistake Tip #12: Don’t Focus Excessively on Expenses or Taxes
Don’t make the mistake of never selling an investment because you don’t want to pay taxes or fees. Conversely, you also shouldn’t ignore the tax consequences. Taxes and fees are just one factor (transaction expenses) to consider when analyzing how a transaction will impact overall portfolio performance.
Bonus Tip #13 (Extra Bonus): Have Fun Investing
Have fun investing because wealth isn’t a destination to be reached, but a journey to be enjoyed. It’s a lifelong process that doesn’t end until you’re six feet underground, so you might as well figure out how to enjoy the experience along the way.
