The Five Worst Investing Mistakes You Can Make

scrambled eggs

Photo: Flickr / Great British Chefs

For decades, public health campaigns have sought to protect us Americans from, well, ourselves.The result: Unless you’ve sworn off all forms of media, you know that you really should avoid smoking, eating too much of the wrong foods and sitting on your rear all day long.

There’s been less emphasis, however, on “healthy” ways to invest. Perhaps that helps to explain the well-documented, self-defeating behaviour of American investors.

In 2010, the SEC asked the Library of Congress to survey the universe of research into investor behaviour. The goal: Produce a list of the typical ways investors shoot themselves in the foot.

You may be surprised—or not—to find that many of the practices that the survey turned up are commonly, often implicitly, promoted by the financial services industry and the financial media. Among the top ways investors sabotage themselves, according to the Library of Congress …

Trading too much
Active traders have lower returns than the market. In an article published in The Journal of Finance, Brad M. Barber and Terrance Odean found that of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that traded most (48 or more times a year) earned an annual return of 11.4 per cent, while the market returned 17.9 per cent. The research is a bit dated, of course, but more recent studies, like those cited in this post show that the correlation holds true over time.

Scrambling to overcome losses
In what researchers call the disposition effect, loss-averse investors sell high-performing investments and hold on to poor performers—but they end up achieving the reverse. Such investor behaviour is the opposite of disciplined rebalancing, in which investors buy and sell (regardless of performance) to return to a predetermined asset allocation.

Focusing on mutual funds’ past returns rather than fees
This may be the one bit of wisdom that’s sinking in with investors who are fleeing mutual funds, in part because of their high fees. Recent article, “We Call Bullshit: Disclosures Don’t Work,” describes how mutual fund disclosures may actually give fund companies a licence to do worse by their clients.

Going with what they know
Investors tend to favour the familiar—their own country, their own region, companies they know and admire. That flies in the face of ample evidence that diversified portfolios help control volatility risk and aid compounding.

Falling prey to manias and panics
“In the past 10 years,” wrote the authors of the Library of Congress report, “two instances of mania followed by panic have severely harmed investors: the bursting of the dot-com bubble in 2000 and the housing crisis. … A diversified portfolio, including fixed income securities, would have mitigated the impact of these crises on investment portfolios.”

Like sitting on the couch and eating your way through a party-size bag of potato chips, following your instincts as an investor may feel good in the moment. Rest assured, such behaviour will catch up with you sooner or later.

So, we’re urging you to eat your metaphorical vegetables. A responsible and profitable approach to investing is based on research, insight, and common sense—not on hunches, fear or irrational “comfortable” behaviour. You are most likely to experience success as an investor once you quit being complacent and stop passively consuming what the financial services industry wants to feed you.

Don’t miss: Lance Roberts shares simple tips for putting your money into hard assets > 

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