Investing is an important part of your personal finances, and it seems simple: Buy low, sell high and keep the profits! Studies have shown, however, that a chimpanzee throwing darts picks stocks better than the average investor! The average investor in the past 20 years made only 2.4 percent, whereas the S&P500 returned 7.7 percent. Investor psychology has proven that the worst enemy when it comes to investing is not the market, but ourselves.
Here are top mistakes that turn investors into their worst enemy:
* Letting emotions get in the way. With all of the volatility we have been experiencing, it is critical to take emotion out of your investing strategy. This is one of the biggest challenges investors face: letting erratic, short-term movements of the markets create anxiety for them, and then reacting improperly. As a result, the average investor did not stay invested during the entire 20-year time period. In general, people allow emotions to affect the way they invest, and instead of staying invested for the long run, they tend to buy high and sell low.
* Ignoring the fees. Not all fees are bad, especially if you are paying for good advice. However, in 2011, 80 percent of actively managed mutual funds did not beat the market yet charged almost 2 percent in fees. In order to just break even, the fund manager has beat the market by 2 percent. Fees can take a big bite out of a portfolio over time. A $2,500 investment in the S&P500 30 years ago would be worth $400,000 today. But if you add in a 1.5 percent mutual fund fee, the total drops below $300,000.
* Not diversifying. Familiarity bias is when you tend to favor stocks with which you have a personal connection. Concentrating solely on a few stocks could be disastrous since you are putting all of your eggs in one basket, especially if it is your company’s stock. Imagine working for and investing in Enron, Bear Stearns or Lehman Brothers and not being diversified. If the company goes belly up, you not only lose your job, but also your investments. See artofthinkingsmart.com for further diversification tips.
* Not knowing what you own. Sometimes it is easy to “set and forget” your investments. People may think they are diversified only to find out they are overexposed and overlapping in a certain asset class. Also, investors can put their portfolio in the wrong hands (Bernie Madoff) in order to get unrealistic returns (Ponzi schemes) in an investment you may not understand. If it is too good to be true, most likely it is.
* Following the herd. This herd mentality means you are buying a stock with large gains and hoping the trend will continue. But, by the time this “financial mania” takes hold, investors buy at a high, and when the market plummets, then sell at the low, going against the “buy low and sell high” mantra. The dot-com bubble in 2000 and housing bubble in 2008 showed what can happen when people chase performance.
Studies show that female investors tend to outperform male investors because men tend to be overconfident and excessively trade. Checking your ego at the door can help you prevent costly mistakes!