Millionaires' Top 4 Investing Errors, and How to Avoid Them
Global financial consultancy deVere Group asked 880 of its high-net-worth clients to reveal their biggest investing mistakes before they looked for professional advice. Most offered examples that fell into four general categories. Although no more than 22 percent admitted to any one, deVere international investment strategist Tom Elliott said that a "majority" had probably fallen prey to at least one of the mistakes. He cops to have also tripped up on these errors.
1. Investing Without a Plan
According to the study, 22 percent of those now-wealthy individuals recognized that they had invested at times without a plan. Elliott put it this way: "You get money from a year's bonus one year. You don't know what to do with it, and you randomly put it into an asset class without considering how it fits [in with the rest] of your assets." Or perhaps you get an opportunity that you think is too good to pass up, so you invest without considering the impact of that move on the balance of your overall portfolio.
Knee-jerk investing can be dangerous. You should consider such factors as how much sector diversification you need, or whether you have the right amount of liquidity -- both now and for your future plans. It's fine to alter your investment plan when circumstances change. However, acting on impulse shouldn't be your financial lifestyle.
2. Making Emotional Decisions About Financial Matters
Many economists talk about the stock market as being rational, with people acting on the best information they have, and according to their best interests. Don't you believe it: Far too many investment decisions are made based on pure emotions: fear, greed, or the desire to be part of the crowd, among others.
Imagine it's December 1999, and you turn to your other millionaire friends and say, 'I'm selling all my tech stocks and putting my money into copper,' " Elliott suggests. At the time, they'd have laughed at you. They also would have been dead wrong to do so. In the months and years after that, the tech bubble popped, while mining did extremely well. But odds are, you wouldn't have made that choice at all. If your friends were holding steady in internet stocks, you would have too.
"That's often described as a herd mentality, and it's extremely difficult to buck that." But steer clear if it you must, or else you're likely to end up buying high, selling low and following the other figurative lemmings off the cliff. Don't simply trust the so-called "wisdom of crowds." If the numbers, history and clear prospects don't support the price of an asset, don't assume that facts and rationality will necessarily be proven wrong.
3. Failing to Regularly Review Their Portfolios
You can be doing everything right and still get tripped up if you don't remember to review your portfolio, letting it roll along as it will until there's a problem. There are two aspects of this, according to Elliott. First, letting your portfolio operate on autopilot means that you're not rebalancing. "[Rebalancing is] a discipline that helps avoid letting winners just run and run until they collapse," he said. You take profits out of investments that are doing well and put them into asset classes that have been doing less well, to keep the asset balance of your portfolio closer to where you want it to be. The strategy helps prevent "an overextended position in an asset class that becomes highly valued just before the bubble bursts."
The second aspect involves having a portfolio that meets your needs. "You might originally invest in a portfolio aiming for retirement, but then you have kids, and in five years you have a wiz kid who wants to go into medical school," Elliott said. There will be times that you shift your portfolio to better serve your evolving situation. Fail to regularly review your portfolio, and you might not be in the best position to handle the needs that arise.
4. Focusing Too Heavily on an Investment's Previous Returns
As the saying goes, past performance does not guarantee future results. Yet it's easy and common to forget that critical principle. "The tendency we all have is to track a fund or stock and believe that because it was the best performer in the last two years or five years, that it will continue to do that," Elliott said. "It's at the heart of what is called behavioral finance. We have anchored expectations of what the stock will do based on previous performance. We always have to look critically at its current price valuations."
When it comes to investing, look forward, not backward. And remember that even the best investors didn't get rich without making the same sort of mistakes as the rest of us.