Mistakes that all investors make

• Make mistakes and improve your investing

• Mistakes are part and parcel of investing and trying to avoid them is futile.  The benefits in learning from mistakes are huge and the perils of ignoring them can be devastating

• Most common investing mistakes come from allowing emotions to dictate behavior.  Panic selling happens when investors develop tunnel vision because of fear

• One of the best ways to recognize and learn from mistakes is to write things down.  Doing so forces you to be more objective about decision making.  Your memory may become fuzzy but your words on paper will not fade away

• Course correcting is one of the biggest advantages that investors have.  If you identify and can stop making the same type of mistakes repeatedly, your chance of compounding successfully goes through the roof

Trying to be flawless

Being too careful and with the aim of preventing mistakes is counterproductive in investing.  Risk is part of investing.  Protecting yourself from adverse outcomes is futile and only leads to suboptimal results.

Investment decisions require judgment based on limited information today subject to numerous variables beyond your control tomorrow.  It is for this reason that success in investing is compared to baseball.  A 40% hit rate is exceptional.

I have encountered clients and investors that believe that bowling strikes can be achieved repeatedly if you are smart money.  Much disappointment awaits those that subscribe to this.

Depending on the type of investor you are and your strategy, the nature of errors will differ.  Once you recognize what the mistakes will look like, life becomes easier.

Investing in stocks require making judgment on businesses.  If you do this, the range of variables that have an impact on the future value of your investment is very wide.  Industry prospects, management capability and pricing power all matter.

An index fund investor making regular contributions to their retirement portfolio navigates a much more limited set of variables.

In general, the more complexity, the more room for mistakes.  Do not overlook this in portfolio construction.

Assuming the current environment will persist                            

In the middle of the crisis, it is difficult to look past doom and gloom.  Making decisions during these periods is a common investing error.

When financial markets rally, it can seem like the party will never end.  When markets crash, the alarm bells ring louder by the day.

Extreme conditions do warrant heighted attention.  This is true in investing and otherwise.  If there is a fire in the kitchen, next week’s meal plan quickly takes a backseat.

The danger is when this causes tunnel vision.  Investors panic and sell when markets fall heavily because they cannot see past the current predicament.  When people do this, they frequently sit out the eventual recovery in prices.  Their reason is always the same: the emotional turmoil was too much to bear, and concluding that “this is not for me”. This being risking my capital.

Many investing regrets have a similar pattern: making decisions in the heat of the moment against better judgment.  The consequences of such actions can be huge if it means permanently checking yourself out of investing.

If this phenomenon can be described as intense zooming in, the antidote is to do the opposite. Morgan Housel states that all past market crashes look like great opportunities and the next one looks to be a great risk.

The next time a crisis leads to sharp selling in the market, ask yourself the following question: is the reason why prices are falling now going to keep them low in 10 years?

The answer is often no. 

When the pandemic hit in early 2020, financial markets tumbled very quickly.  Uncertainty was heightened.  Nobody had lived through such a crisis before.  Fear and caution were warranted.

Zooming out means considering whether the destruction in market values of businesses caused by Covid-19 would remain 5-10 years later.  For businesses essential to the way we consume and transact?  Probably not very high.

Letting emotions run wild

Many investing mistakes come from letting emotions play an outsized role in decision making.  Controlling this will allow you to reap dividends immediately.  Check yourself before you wreck yourself.

Uncontrolled fear and greed put us in emotional states that obscure clear thinking.

At its worst, fear dulls appetite for risk and has a huge opportunity cost.

I was once advising a young client investing in retirement who could not bear to see the value of his savings fluctuate.  The fear of seeing temporary drops in account values due to market volatility was simply too much to bear.  Such situations are not uncommon.  For someone decades away from retirement, being conservative to this degree does a disservice.

Greed and rising markets can engender overconfidence in investors.  This frequently takes place and can cause investors to mistake luck for skill.

A healthy dose of fear and greed is necessary.  Successful investing requires you to not always conform to the masses.  Fear reminds you to not jump aboard speculative investment schemes.  Greed gives you the confidence required to purchase assets while everyone else is selling.

Uncertainty is the root of emotional triggers.  As the number of potential outcomes to a situation increases, our imagination plays out different scenarios that can unfold.

Being objective is the best way to combat this, and my favorite method is to write things down.  Since using an investment journal close to a decade ago, the clarity in my decision making went up greatly.

Before making an investment, pen down your thesis.  Coming back to this can help keep track of how accurate your previous assessments were.  It is possible that your investment turned out the way you hoped, and for entirely different reasons than what you thought. 

Having no information filter

Without being deliberate about what information you consume; it is easy to become unsettled and for your mental boat to rock.

All information is either from the source, or through a lens.  The latter comes with a narrative serving a purpose that might not align with yours.

Federal Reserve Board minutes are publicly available for all to read.  What the financial press has to say about the same meetings uses colorful adjectives designed to maximize eyeballs.

Do not blame the news outlets.  They are just doing their job.

The next time you see a headline claiming that stocks are sliding after a 2% decline, remember this: in 2023, the S&P500 had 12 consecutive 2% declines during a year where the index went up by 24%.

Figure 1: the S&P500 had more than 10 2% declines in 2023

Source: Reuters.

If you are a stock investor, reading through company filings and transcripts tells you much more than reading articles from the press.  The authors frequently take que from how share price has reacted to an event such as an earnings release in the ‘analysis’ they present.

Acceptance that media outlets are biased goes a long way in remaining grounded when the prose tries to stir emotion.  Better yet is to only use those that you think are reliable.  Best is to go to the source.

Always be prepared to change course

The world is in constant change, and it is perilous for investors to stand still.

Knowing what types of mistakes, you are exposed to and recognizing them allows you to course correct.  In any long-term pursuit, course correcting allows you to move to your destination in a more efficient manner.  This means cutting out the weeds in your investment portfolio by recognizing that your thesis was wrong.  Or staying put when markets fall, and the headlines make you feel jittery.