This blog post was inspired by the writings of Nick Murray – particularly his book, “Behavioral Investment Counseling.”
If you do not have a unified philosophy of investing, you may end up in this category. You buy some shares of a stock that was recommended by a friend. You buy an actively traded mutual fund in your taxable account. You buy a separate actively managed mutual fund in your retirement accounts. You may buy some passive index funds here and there. By the end you have essentially widely diversified index funds but at a much higher cost. There also may be gaps, redundancies, and fee inefficiencies in the mix.
This one can be fatal. Particularly if you narrow your entire portfolio down to just one idea. Going into the year 2000 there were thousands of investors whose portfolios were invested primarily or exclusively in highflying technology stocks. When the broad equity market went down 50% many technology stocks went down more than 80%.
Some companies of the past despite decades of success such as Pan Am or Wang Laboratories have dissolved completely along with all of the investor money. Can you tell what will happen in the future for a company like General Motors? Or Cisco? Or Coca-Cola? Many believed in the outstanding future success of Polaroid, Xerox, and Kodak. Where are they now? Spread the risk around.
This is what happened to many stock investors in 1999. They had a complete loss of an adult sense of danger. When euphoria hits, you no longer fear the loss of principal. You assume stocks will keep going up and up and somehow a small gain feels like a comparative loss. It feels like a loss until a real loss comes along and then you feel stupid and silly in retrospect. Beware of the four dangerous words, “this time is different.”
The biggest bear markets are simply correcting the biggest bull markets. You manage panic tomorrow by managing euphoria today. The two concepts are linked. When all is crashing in the headlines or screaming negativity it sure can feel that the world is coming to an end. It is not the end. All markets decline temporarily. The overall trend is, however, a permanent rising. This is the genius of free-market capitalism. It is a powerful engine in a global economy. Don’t bet against the global economy.
Leverage is a powerful tool. It can magnify your gains, but it can magnify your losses as well. Leverage is a more potent tool than many investors can handle. There are examples of people in the year 2000 who over-leveraged their homes with adjustable rate debt to buy technology stocks. This seemed to make sense to them at the time. It seemed crazy to me at the time and obviously it was crazy. Other uses of debt are subtler, but often end up just as harmful. If you can buy an investment without debt, do so.
6. Speculating When You Still Think You Are Investing
Buying technology stocks on margin in the year 2000 was obviously a speculative bet. It did not pay off well. Buying shares of Bitcoin in 2017 may have paid off extraordinarily well for some. Nevertheless, speculation is not the same as investing and you need to know which is which.
With investing you are looking for a reasonable return on your principal as well as the return of your principal. It is not based on a guess about the direction and should be the result of a reasoned value analysis. Short-term trading is speculation. If you’re expecting a quick price change because of changing opinion or a passing fad, realize you are speculating. Investors have a reasoned argument based on long-term improvements in earnings, cash flows, and dividends. It is okay to speculate with a small portion of your portfolio, but never speculate with your core capital and never confuse speculation with investing.
7. Investing for Current Yield Instead of For Total Return
This is a common mistake for American retirees. Even those who retire early tend to think in terms of current yield instead of the total return. Who wouldn’t want a goose that lays the golden eggs? Is the egg a piece of interest? Is the egg a dividend paid? It can be. The problem with chasing high current yield is that it can inadvertently drive you into limited number of segments with higher risk, higher taxes, and keep you out of investments with high appreciation. Look at the total return of equities. Over the long run it has been about twice that of bonds (net of inflation, it is closer to three times). Equities, not bonds, are thus vastly preferable for long term income investment. Many of these stocks paid little or no dividend.
8. Letting Your Cost Basis Dictate Your Investment Decisions
The cost of your investments is critically important. But focusing on avoiding expenses or on avoiding paying taxes can lead to suboptimal investment decisions. For example, I knew someone with 80% of his net worth invested in a single stock. He did not want to sell it because he would have to pay an enormous bill for capital gains tax. As a proportion to his gains it was a small amount and one he could easily afford. It would have been the prudent thing to do, since he was lucky with investing and selling would reduce his risk level and allow him to better diversify. Subsequently, the stock experienced a 60% drawdown. He was devastated and sold at the bottom. He ended up paying less tax, but paid an enormous financial cost. Don’t be penny-wise and pound-foolish.
Do you agree with this list? Which of the 8 mistakes have you made? I will admit that I have made all of them at some point in my investing history. If you limit the losses and learn from the mistake, you can thrive in the future. I’m living proof.