4 Common Investing Mistakes that Really Hurt

December 14, 2022

Famed economist Paul Samuelson once said: "Investing should be more like watching paint dry or watching grass grow.  If you want excitement, take $800 and go to Las Vegas."

Most of the investing mistakes noted below flow from not understanding the wisdom of this Nobel Laureate in Economic Sciences who made contributions to several branches of economic theory.

Here are four of the worst investing mistakes you can make.

1. Make investing complicated

Warren Buffett said it well: "Investing is simple but not easy."

It's simple because you can capture the returns of stocks and bonds in one or two mutual funds or ETFs.

For example, Vanguard's LifeStrategy funds are allocated between stocks and bonds for different levels of risk, starting with an income fund and, at the other end of the spectrum, a Growth Fund heavily tilted towards stocks.

These funds are broadly diversified and low-cost, with an all-index, fixed-allocation approach that provides a complete portfolio.

You could simply buy and hold this fund and change to a more or less conservative one as your need requires, which should only be done when your risk profile changes.

The benefit of diversification deserves special attention.  Over 70 years, from 1950 to 2020, the worst year for bonds was -8% compared to -39% for stocks.  A broadly diversified portfolio permits you to weather market volatility and adhere to your investment plan.

Investing isn't easy because the financial media inundates you with daily "noise," stirring feelings of fear and anxiety to incentivize you to take immediate action.

If you keep it simple and avoid the noise, you are well on your way to being a successful investor.

2. Not having an investing plan

You wouldn't drive to an unknown destination without GPS to guide you.  So, why would you think you can invest without a plan?

An investment plan is a critical part of your overall financial planning.  It considers your need to take a risk, your emotional ability to tolerate market volatility, global diversification, and your asset allocation (the division of your portfolio between stocks, bonds, and cash).

Your investment plan also sets your long and short-term goals and incorporates recommendations for achieving them.

Without a carefully thought-out plan, you'll have little guidance for your investment decisions, which is a prescription for investing failure.

3. Relying on intuition

Trying to predict the direction of the market is extremely difficult.  

Regardless of your confidence in your intuition, the evidence is compelling that "experts" who make predictions are often wrong.

As one commentator noted, "The bottom line is that the research shows that when it comes to predicting economic growth, interest rates, currencies or the stock market, the only value of investment gurus is to make weather forecasters look good."

If this is their track record, why would you think your intuition would be any better?

4. Not paying attention to fees

The Securities and Exchange Commission wants investors to appreciate the significance of costs and fees on expected returns. 

Fees include transaction fees and ongoing fees.

Transaction fees are charged at the time you buy, sell or exchange an investment.  These fees, like others, reduce the amount of your investment portfolio.

Ongoing fees are even more pernicious.   They are often expressed as a percentage of the assets being managed (like 1% of your assets), so they seem deceptively small, but they add up because the amount of the fee reduces your investment balance, and you lose the return you would have earned on that fee.

Consider the impact of a 1% advisory fee on a $1 million portfolio, earning an average of 6% a year over a 20-year period.

Total fees paid over this time would be $364,000.

Next, consider the impact of deducting these fees directly from the portfolio since doing so will reduce the amount available for investment.

Investors whose fees are collected in this manner will lose an additional $189,000.

The real cost to investors of paying 1% of fees on this portfolio and having those fees deducted directly from assets held by the custodian is $553,000, or 25% of the total gain in the portfolio over a 20-year period.

You can run different scenarios by using this calculator f the website of Larry Bates, a Canadian investor advocate, author consultant, and speaker.

You need to consider the management fees charged by mutual funds (called "expense ratios") and those charged by a financial advisor to manage your portfolio.  Their fees range from 0.50% to 1.25% of your assets under management.  When combined with the expense ratios of actively managed mutual funds, you may lose a significant portion of your gains to fees and costs.

Recommendations

Here are some recommendations to avoid these common investing mistakes:

1.  Keep investing simple.  One or two index funds or ETFs may be all you need.  Avoid complex investments, which often have high fees.

2.  Prepare an investment plan that will keep you on track and help you avoid making emotional decisions.

3.   Ignore the financial media and pundits who claim to be able to predict the market's direction or the stock "winners." Much of the financial media is focused on short-term news, which is correctly described as "noise."

4.   Invest in low-cost index funds and ETFs.  They are available from well-known fund families, like Vanguard, Schwab, and Blackrock (iShares).

5.    If you need to retain a financial advisor, look for one who charges an hourly fee or a flat retainer instead of a fee based on your assets under management.  

There are low-cost financial advisors who discount fees they charge for assets under management without sacrificing the quality of your portfolio.  

Darrell Armuth founded Sensible in 1994. Since then, he has served hundreds of clients. Darrell is a Certified Public Accountant certified by the state of Nevada.