In my 20-plus years as a financial advisor, I have seen plenty of investor mistakes, some of which I made myself! To be a successful long-term investor, it seems to me that avoiding the big mistakes is often more crucial than finding the next big thing.
Fortunately, almost all the big mistakes one could make are avoidable. In fact, the mistakes are often created not because we miscalculate the math involved in an investment, but rather because we misunderstand our own emotional response to financial matters. To be blunt, human beings are very prone to shooting themselves in the foot when it comes to managing their investments. It is important to acknowledge that we are often our own worst enemy in finance.
Here, then, are a couple of the top mistakes I have seen investors make. We will be adding to this list in future columns.
Not acknowledging and calculating risk
All investing entails some risk. A working definition of an investor is essentially "one who willingly puts their money at risk in an attempt to earn a rate of return better than what is available in a ‘risk-free’ environment." The key words are “willingly," "risk" and "attempt." I believe one must enter the investment arena with forethought, fully understanding that there is always a risk of loss and no guarantee of success. It is simply a standing rule of investing that without risk, there can be no potential of higher return.
Human nature is such that we don't want to accept this "no risk = no return" tenet. In fact, it is exactly our risk-averse nature that makes us serially susceptible to Ponzi schemes. We want to believe that there is a strategy or investment product that affords high return with little or no risk. Time and again, when someone in a suit, bearing spreadsheets and unsubstantiated facts offers an investment that sounds too good to be true, checkbooks will open.
If you are unable or unwilling to accept some measure of risk (in other words, you may lose money), then by definition you are also not ready to be an investor. Instead, perhaps you are a saver. In my experience, all of us should be savers to some extent in order to achieve our financial goals. However, being an investor is a more selective endeavor in that it mandates taking risk. Make sure you are ready to accept investment risk before you begin.
Failure to set a realistic time frame
Almost everyone understands that the stock market is notoriously unpredictable on a day-to-day basis. What drives the market today might just as well reverse tomorrow. In my view, divining the daily direction of the market is a futile task that even professional traders often get wrong.
It is only over the course of a market cycle (typically five to seven years) that the stock market can start to produce more predictable returns. Within a market cycle, it would be common to see 75 percent of the years positive and about 25 percent of the years producing negative stock returns. The distribution of positive vs. negative years within that market cycle is, in my experience, essentially random.
If you were to start investing today, neither I nor anyone else could accurately tell you whether your first year would be profitable (and thus cushion the effects of the inevitable disappointing year) or not. If the first year is not profitable, one is more likely to change strategy or exit the market altogether. Yet, given market history and the normal dispersion of returns, this would likely be a mistake.
Bottom line? Many investors in my experience view themselves as long-term, patient investors. However, when investment results are temporarily unpleasant, they begin to think in a very short-term manner. In my experience, to be a successful investor, you must always be thinking in terms of market cycles of five to seven years. Short-term thinking damages long-term results.
Jonathan Lokken, CIMA, is managing principal of Lokken Investment Group LLC in Lewes. He has been professionally managing client investments since 1997. For more information, go to www.lokkeninvest.com or call 302-645-6650.
Disclaimer: The foregoing content reflects the opinions of Lokken Investment Group LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. All investing involves risk. Asset allocation and diversification does not ensure a profit or protect against a loss.