Fundmastery Blog

Kurt Brouwer September 10th, 2007

Making mistakes is part of life and part of being an investor. My goal here is to help you become a better investor. These five mistakes are easily avoided, however they are not easily remedied once made.

Five Mistakes Investors Make – Over and Over

1. Failing to plan for emergencies: In order to be an investor, you have to commit to saving money consistently, year after year. You also need to have some savings set aside from whatever you plan to invest. Before you make any long-term investments, you need to have:

• Rainy day fund – 1-3 months of expenses

• Insurance – health and life

Once you have some money set aside for emergencies and you have adequate health and life insurance, the next step is to save for major purchases such as a car or a home. Also, if you have credit card debt, you should be paying that off first. Finally, when you have those things taken care of, you are ready to start investing. One exception: if you have a retirement plan at work such as a 401(k) plan, it may make sense to contribute to that if your company matches your contribution.

2. Trying To Get Rich Quickly: In my experience, you get rich slowly – or not at all. Sure, there is the occasional lottery winner or some other story about someone who made it big and did it quick. If that happens to you, great. But it is very unlikely. Unfortunately, many people fail to ever achieve financial freedom because they have avoided the steady, unexciting work of saving money, investing it wisely and letting time work for them. Instead, they have put money into one scheme after another. All they have left is dashed dreams and some good tales for ‘wudda, shudda, cudda’ time. The fundamental principle of compounding is that a steady return compounded over many years will grow as interest grows upon interest and upon yet more interest you have earned. In short, your money is working for you equally as hard as you worked to make it.

2. Being Di-Worsified: Very often I see portfolios that are not diversified, but di-worsified. All technology stocks. Or, all bonds or all gold and silver or real estate. Diversification is not terribly exciting as a topic, but it is a lifesaver when things go south. By having investments in different asset classes such as stocks, bonds, real estate and even cash, you can help ensure that you will not be severely hurt by a downturn in any one area. Also, you have something to do when one asset is getting clobbered. If stocks are down, but bonds are up, you can periodically sell a modest amount of bonds and put that money to work in stocks, when they are down. It’s called buying low. A few years later, bonds may be down and stocks up. In that case, you put a little more in bonds-while they are cheap-by selling stocks when they are expensive (see Buy When Bonds Are Flooding the Street and Aisle Nine–Muni Bond Funds). After you have achieved some of your goals, you may be able to take on a bit more risk, but do not get seduced by the lure of high returns. Remember that steady returns compounded year after year are the key to reaching your goals.

4. Making Emotional Decisions: Do you get excited when your investments go up? Do you get down when they are falling? Good, that just means you are human. The next issue is important. Do you ignore your emotions and stick to your plan or do you let emotion drive your decisions? For example, investors often react much more strongly to the recent past than it really warrants. If technology stocks have been going up for a couple years, investors start piling on the bandwagon. Often, they do so just at the time the wagon is overloaded and about to roll over. When stocks are high, investors often pile on thinking they will go higher. On the other hand, when the stock market is having a 25% off sale, you cannot give stocks away. If you are investing in a solid stock mutual fund (see here and here and here) with a good record of picking stocks, wouldn’t you rather put your money in when stocks are on sale? The best thing for an investor with cash on hand is falling prices, whether it is in stocks, bonds or real estate. Take advantage of the sale opportunities you get. The reason these investments are on sale is because other investors are dumping them due to emotion. Keep your emotions under control and you will be a better investor.

5. Just Winging It. You have to learn before you earn. Either educate yourself or find someone knowledgeable who can help you. If you are not willing to put in the time to learn, then you need to get some help. Wise counsel exists in many places. Books, blogs, magazines, friends, adult education courses-all of these are useful for learning about investing. Make use of them or find professional help. But do not put your financial future on the line without knowing what you are doing. It has been said–with some truth–that people plan out their vacations more than they do their investments. A little research or a bit of wise counsel can go a long way. In the investment world, the learning curve is steep and the price of admission is high. So, figure out how to get a solid portfolio and then stick with it.

• Investing , Mutual Funds , Personal Finance
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