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Common Investor Mistakes

February 19, 2014 | By |

Money Plant

Video: It’s interesting to think about investing as a process of avoiding mistakes because it really is a business in which we can succeed by avoiding mistakes. Charlie Ellis likens it to the game of tennis, in which, you know, any one of us could beat Roger Federer even if we’ve never played tennis before in our lives if all we do is just routinely get the ball back across the net.  That’s all we have to do, just don’t make mistakes, get the ball back across the net. And if we do that and make sure that he’s the one who eventually makes a mistake, we’ll beat even him. Well, of course, it’s easier said than done.

As investors, mistakes are legion. Probably the first mistake most investors make is to not save enough in the first place. You can’t invest money that you haven’t first saved. And so most people spend too much and don’t set aside enough to invest in the first place. Pretty much all of us know somebody who makes 70- or 80 percent as much as we do. And do they lead a bleak lifestyle vastly inferior to our own? No, their lifestyle is fairly similar to our own. So can we lead a lifestyle similar to theirs and save 20- or 30 percent of our income? Well, of course, we can. Of course, we can. And if we do that, in just a few years, we have a year’s worth of our income saved. Then two years, then three years, and it goes on from there.  Well, in so doing, we build up some real wealth.  And most people just don’t do that.

Another mistake that people often make is to have an expectations gap. They expect the markets to, in effect, do their savings for them by producing returns so that they don’t have to save so much. But in a world of low yields, you’re not going to get huge returns.  Notwithstanding the fact that occasionally you get a nice 20% bull market, in a context of a 2% yield just by rising valuation multiples, yes, that will happen from time to time.  But your long-term returns, when yields are low, are going to be pretty anemic. And does that mean that you shouldn’t save? No, of course not.  It just means that you should be patient.  You should recognize that long-term returns will be relatively anemic and just be patient. Save a lot.  Is it better to save more, spend less, retire a little later, or to spend more, save less, retire sooner, and run out of money halfway through retirement?  Oh, my goodness. That’s a disaster, but it’s not a disaster to do the opposite.

A third mistake that’s very common and catastrophic is the tendency for people to chase past success. We’ve got to be in just about the only business in the macro economy in which most people follow a pattern of when product is offered at deep discount, well, customers flee, and when product is offered at a massively increased price with a new story attached to why the price should be so much higher, customers batter down the doors of the store, strip the shelves bear. Well, it’s the nature of the investing business that we like what’s gone up and we shun what’s gone down. Rebalancing—buy what’s gone down, trimming what’s gone up—is much more profitable.  For the long-term investor it makes a lot of sense to pay more attention to what’s gone down and to rebalance into what’s gone down and to take profits on what’s gone up. It goes against human nature.  We all like what’s gone up. We all get attached to where we’ve earned our nicest profits.  And yet it makes a lot of sense and it makes a lot more money to pursue the opposite path.

So these are three areas in which people do make mistakes, the notion of buying what’s expensive, selling what’s cheap, instead of doing the opposite.  The notion of having an expectations gap, expecting the markets to deliver more than is plausible. And the notion of not saving enough in the first place. These are three very, very common errors. 

Disclosures

The views expressed are for general information purposes only and are not intended to provide specific financial, accounting, or legal advice. The views and opinions expressed are those of the speaker and are subject to change based on market and other various conditions.  These views do not necessarily represent the view of Charles Schwab Investment Management or its affiliates.

Rob Arnott/Research Affiliates are not affiliated with Charles Schwab Investment Management or its affiliates.

Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab’s proprietary funds, is an affiliate of The Charles Schwab Corporation.

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