Sunday, July 22, 2012

Ten Investing Mistakes

This comes from Barry Ritholtz, who runs an investing firm, but knows stupidity when he sees it. And Mr. R.'s Top Ten Stupidities are: ...

1. High fees are a drag on returns: Fees are an enormous drag on long-term performance, according to every study that has ever looked at this issue.

2. Reaching for yield: There are few mistakes more costly than “chasing yield.” — just ask the folks who loaded up on subprime-mortgage-backed securities for the extra yield how that worked out ...

3. You (and your behavior) are your own worst enemy: Your emotional reactions to events are yet another detriment to your results.

4 Mutual funds vs exchange-traded funds: The average mutual fund charges far more than the average ETF. Whenever possible, I recommend substituting a low-cost ETF over a more expensive mutual fund.

5. Asset allocation matters more than stock picking: The decisions you make about the mix of your assets have a far greater impact on your success than your stock picking or market timing.

6. Passive vs. active management: Active fund management — when managers try to outperform their benchmarks through superior stock picking and/or market timing — is exceedingly difficult. It has been shown repeatedly that 80 percent of active managers underperform their benchmarks each year.

7. Not understanding the long cycle: Societies, economies and markets all move in long — or secular — eras. Sometimes these periods are positive (1946 to 1966 and 1982 to 2000, for example) and are called secular bull markets. Sometimes they are negative (1966 to 1982; 2000 to ?) and are called secular bear markets.

8. Cognitive errors: Beyond those emotional foibles, many investors suffer from cognitive foibles. These are the errors inherent in your wetware — namely, the way your brain has evolved over the millennia.

9. Confusing past performance with future potential: We’ve all seen the boilerplate disclaimer that comes with anything investment-related: “Past performance is no guarantee of future results.” Despite its ubiquity, this warning is routinely ignored by investors.

10. When paying fees, get what you pay for: It always surprises me how much money some people are willing to throw at others to manage their financial affairs when it is not necessary.

There is only one item above with which I have a small issue, and that is 7: "bear cycles" and "bull cycles." These cycles do exist, but you can only know what they are and when the occur after the fact. (Which is not, sad to say, particularly useful.)

As I've said here previously, investing is really, really simple ... but difficult to execute, because all us upright mammals (with opposable thumbs) are emotional, flighty creatures. We chase good news and run from bad news -- another way of saying we tend to buy high and sell low, exactly the reverse of what we should be doing.

Which is why we need to set up an allocation plan for stocks, bonds and real estate and stick to it.


Celshader said...

I have a minor quibble with #4. For Admiral-status Vanguard funds, the expense ratio on the ETF and mutual funds are identical. The ETF might also suffer from bid/ask spread and trading costs if the investor invests frequently during the year.

That said, I would definitely use ETFs in a 401(k) that offers them if the mutual fund alternatives are worse.

Right now I have no 401(k), so I'm making do with Vanguard mutual funds in my IRA and taxable accounts.

Steve Hulett said...

Vanguard's ETFs and Admiral Shares of its mutual funds are (usually) the same.

In cases where it IS the same, I opt for the mutual fund. If you buy and hold for a long time, either option is okay because it doesn't make a lot of difference.

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