10 Common Investing Mistakes

Oct 09, 2018, 02:27 PM

AAII.COM

From stock-picking to mutual funds to index funds, the numbers stack the odds against us. This is before considering our own biases, which can’t be quantified. Let’s look at 10 common mistakes that investors make.

  1. Investors tend to expect the future to look like the recent past. When stocks are going up, we expect them to continue, and the opposite is true. We believe that an object in motion will stay in motion. In 2007, after years of strong gains and with prices getting above the dot-com peak, many people surveyed thought that the market would go up the next year. And when stocks cratered during the great financial crisis, the percentage of people who thought the market would be higher 12 months into the future was cut in half. Successful investing is about finding the balance between being prepared for the good times to last while also understanding that the next bear market is always right around the corner.

  2. Investors behave as if the price we paid for a security somehow should be factored into how we view the investment going forward. Stocks don’t care that you hope to achieve a 20% return in the next 12 months.

Sir John Templeton said, “The four most dangerous words in investing are, it’s different this time.” I think the most dangerous words in investing are “I’ll sell when I get back to even.” Anchoring to your purchase price is dangerous because most stocks are losers. Most stocks won’t be sold at a profit or even at a breakeven price. There is nothing wrong with taking a small loss, but big losses are hard to recover from financially and emotionally. We can all hope that a stock comes back up in price. When waiting for this to happen, keep in mind this observation from hedge fund manager David Einhorn, “What do you call a stock that’s down 90%? A stock that was down 80% and then got cut in half.”

  1. Investors make the mistake of thinking about the stock instead of the business. Not everybody can be a security analyst, but first and foremost, shares represent a piece of ownership in a real business. With instantaneous access to information, especially the price of a stock, it’s easy to forget that a stock is more than a price on a computer screen. You don’t have to be Benjamin Graham to figure out whether a business has improved or deteriorated. If you are selecting individual stocks, at least be aware of the company’s historical and current business model and performance so you can identify when something significant changes.

  2. People loathe to admit that they were wrong about anything, and this is particularly true with investing. Most people would rather hope they’re right than admit they’re wrong.

The best way to prevent large losses is to take small losses. The tricky thing with taking small losses is that you will be wrong again and again and again, and this can be difficult to deal with. In “The Money Game” (Vintage, 1976), the author who used the pen name “Adam Smith” described how emotional people get when investing. He wrote, “A stock is for all practical purposes, a piece of paper that sits in a bank vault. Most likely you will never see it. It may or may not have an Intrinsic Value; what it is worth on any given day depends on the confluence of buyers and sellers that day. The most important thing to realize is simplistic: The stock doesn’t know you own it. All those marvelous things, or those terrible things, that you feel about a stock, or a list of stocks, or an amount of money represented by a list of stocks, all of these things are unreciprocated by the stock or the group of stocks. You can be in love if you want to, but that piece of paper doesn’t love you, and unreciprocated love can turn into masochism, narcissism, or, even worse, market losses and unreciprocated hate.”

  1. People often look to others for approval. It’s comforting when somebody on financial television says something positive about a stock that you own. It’s natural to seek out opinions that agree with you...