3 Deadly Investor Traps
When high net worth individuals like you invest, you must be cautious. You’ll find many serious investment errors or traps that are easy to fall prey to. Three of the most deadly traps are gambling with your money; mistaking a lot of “stuff” for true diversification; and mistaking activity for control. Let’s briefly discuss each in turn.
Gambling With Your Money
A friend of mine is reading “Fooling Houdini” by Alex Stone. It’s a book about magic. According to my friend, Stone says that as America emerged as an empire and wealth started accumulating, gambling became the nation’s favorite pastime. Stone adds that the rise in gambling coincided with the widespread investment of private funds in financial markets. I can agree that there is a certain kinship between gambling and finance. Both require nerves of steel and a tolerance for risk. Both are often guided as much by luck as by skill. Both can be fueled by greed. But, folks, it’s time to separate gambling from investing.
Too many high net worth people today mistake gambling and speculation for prudent investing. Investing requires careful appropriation of investment capital in such a way that the risks are minimized and certitude (while never close to being absolute) is aimed for. You increase your investment acumen and avoid “gambling” when you refuse to try to pick the best stocks. You invest more wisely and decrease speculation when you don’t try to time the market. You also reduce “gambling” with your money when you refuse to rely on a stock’s past performance (sometimes called track record investing.)
All these forms of investment “gambling” entail a forecast. Someone is attempting to forecast and predict what will occur in the future. But no one can read the financial future. Whether you are forecasting or you’re paying someone else to do it doesn’t matter. In either case my opinion is that forecasting is still speculating and gambling with your money.
Mistaking Lots Of “Stuff” For True Diversification
A second deadly trap for investors is having your money in many places but not really achieving diversification. Some investors believe that if they have a lot of items on their statements they are well diversified. I’ve seen high net worth investors who have a collection of 100 stocks who assume they have a well-balanced portfolio. In one sense they have a point. If any one company goes under, the rest of the holdings could save the portfolio. But what if all 100 stocks are in the same asset category?
When you have all your investments in one stock asset category you need to realize that all those investments will tend to move (up or down) together. Often losses occur across an entire asset category so in this case the 100 stocks would provide little protection. For example, did you know that the largest (and supposedly safest) U.S stocks that make up the S&P 500 lost more than 40% of their value over one recent three year period?
True diversification means spreading your funds across different stock investment categories and in other investments. It means investing in both stocks and bonds. It means investing in different categories of stocks like income stocks, growth and income stocks, growth stocks, and aggressive growth stocks. It means investing in the U.S. market and internationally. There’s more to diversification than I can tell you here.
Mistaking Activity For Control
A third deadly trap for investors involves thinking you’re in control when you’re not. Have you seen the internet videos and TV commercials that show how you can “easily” trade, at low cost, from the comfortable confines of your living room with the able assistance of Acme SureThing and their “vaunted” research? The illusion these ads create is that you’re in control of your own portfolio and financial destiny if you buy and sell frequently. I beg to differ.
Frequent trading, stock picking, forecasting and track record investing all create a false sense of control. Most often, the more active you are in using these tactics the more out of control you are. For example, the more frequently you trade, the more a large part of your return is taken out of your portfolio in the form of commissions, hidden market impact and bid/ask spread costs.
There are no short cuts in investing. Growing your investments takes knowledge, planning, and time. I could tell you that it’s easy if you just own equities, diversify, and rebalance but that’s an oversimplification. It’s like me saying to you, “Of course you can make it in major league baseball. Just practice until you can hit the fastball, curve and slider.” If things were easy we’d all make the majors and we’d all have vastly growing portfolios.
So keep educating yourself. Talk to proven experts who have a track record of investment success. Get a clear picture of your investment goals. And stay away from the deadly traps most investors fall into.
In the free downloadable report on my website, The Perceptive Investor’s Manual, you’ll find more information about the three investor traps mentioned above plus four more traps in the section entitled “The Seven Deadly Investor Traps.”
Feel free to read the many educational blog postings on my site. You’ll find a few more reports you can download, too. Or you can call me at 203.453.1017. May all your investments succeed.
Much of what you read here is based on information Fred Taylor so generously shared with me. Thanks, Fred.