Investor Mistakes

I was recently asked by a friend to come up with three mistakes that investors make.  These were the three that immediately came to mind:

Like in dieting, investors want to believe there is some magic bullet to investing.  They want to believe there is an easy and painless way to make high returns, yet take little to no risk.  They also equate market volatility, particularly as that volatility relates to market declines with risk of ruin.  That's why you see so many people investing in restaurants, real estate projects they don't understand and the like.  These investments often end poorly but the investors don't find that out till the end.  The reason for this is usually because whatever they've invested in is usually not marked to a realistic market price or any losses are not disclosed until it's too late.   I once had a prospect that brought me her portfolio to review and in it was a promissory note for $10,000 from a local motel that billed itself as a "place for couples to relax"-basically a sex motel.  When I asked her about it, she told me that it was something that her daughter had recommended she invest in.  She was thrilled with the investment she said because she was being paid 13% on it.  I looked into it for her and found out that it was bankrupt and had been for years.  Not only had she lost the $10,000 she didn't even know that she wasn't getting paid.

People also don't understand the long term ramifications of high fees.  I'm reviewing a portfolio right now that has a bunch of high cost mutual funds and is carrying a management fee of 2%.  The mutual funds have expenses in the 1-3% range so this person is paying somewhere north of 3% each year in fees alone.  Some of these same mutual funds can be replicated using ETFs, especially since many mutual funds these days are closet index funds.  Most basic ETFs have management fees under 25 basis points and many are much lower than that.  Most folks don't ever seem willing to do this math.

Finally I would say that most investors have no plan for their investments.  That is they have no long-term view of their portfolios and have never properly analyzed their own unique risk/reward characteristics.  Because of that you often see a huge imbalance between how somebody is or wants to be invested and what their risk profile says they should be doing.  I once had a prospect show me a $150,000 portfolio that he wanted to grow to an unrealistic sum over the next 10 years.  He also then listed all of the things he wanted to do when he retired.  All this meant that he was going to need more than two million in 10 years and he wasn't planning on funding his account at a rate to make this doable.  I pointed all of this out to him.  I also told him that he was going to have to save more for retirement then he was currently projecting and then pointed out that if these were in fact his goals then he was going to have to become very aggressively committed to the stock market.  I also told him that even with an aggressive allocation to equities he was unlikely to meet his target and that he would have to be comfortable with a high growth/ highly volatile investment plan.  At that point he looked at me and replied "who said anything about the stock market?  I want all of my money invested in bonds."  This was a an obvious mismatch and we never connected.

Finally I'll give you one more generalization that I've seen with investors and that, especially when they are younger, women tend to be better long-term investors than men.  My opinion as to why this is has to do with an observation that women tend to be in better touch at a younger age with how much risk they are comfortable with than men.  Men seem to become better at this after 40.  

Back early next week.  Enjoy what should be a fine summer weekend folks.  Those of us that live in the north don't often get weather like this and it's been especially lacking in this rain drenched year!