"The investor's chief problem - even his worst enemy - is likely to be himself." - Ben Graham
Ben Graham, considered one of the most successful investors of all time, knew of what he spoke. Most of the mistakes made by investors are the result of their behavior, which is often driven by their emotions. Fear and greed can drive people to do things they regret. In the realm of investing, that usually means making costly decisions based on reactionary impulses. It’s what makes investors flee the market after a steep crash; or buy into a market rally near the top – both of which can have a devastating impact on their long-term investment performance.
When Warren Buffet said, “Be greedy when others are fearful and be fearful when others are greedy,” he was talking about taking advantage of investors’ behavioral mistakes. Investors who lack clearly defined objectives and a well-conceived strategy for achieving them are much more susceptible to making these costly mistakes.
Trying to Time the Market
It has been well established through decades of investment data that no one can predict the direction of the market with any degree certainty. Market crashes occur unexpectedly, which is why the market crashes. Because no one sees them coming, they trigger panic selling and smaller investors are typically the last to get out. As the stock market recovers, smaller investors tend to be the last to get back in. If you sold your equities during the 2008 stock market crash, it probably took you five to eight years to recover your losses – that is if you bought back in (many investors didn’t). However, if you held your position and rode out the crash, your portfolio may have more than tripled since the market bottom.
Trying to Pick Winners
Investors who try to pick individual stocks do so because their analysis tells them the stock is mispriced – that they know something the stock market doesn’t. However, decades of research has shown that stocks tend to be fairly priced due to the efficiency of the stock market. Because of that, it is rare that an investor can consistently pick winners. The research shows that investors who try to pick winners – stocks or mutual funds – do no better than investors who simply invest in the S&P 500 index with far less risk and investment costs. 1
Investing too Aggressively or Conservatively
Investors, who don’t have a clear strategy based on a specific risk/return profile, tend to be either too speculative or too cautious in their investment approach; and either can be disastrous. For many investors, it comes down to misunderstanding or miscalculating investment risk. Investment risk is essential to long-term investment performance, but you need to be able to balance the amount of risk you can tolerate with the amount of risk that is needed to generate the returns you need to achieve your objective. While you can’t really manage the performance of your investments (that’s up to the markets), you can manage the risk in your portfolio.
Lack of Patience and Discipline
Studies have shown that investors who frequently look at their investments tend to underperform the market. 2 That’s because they are more likely to make changes to their portfolio during extreme market moves. They are the ones most likely to follow the herd, which is almost invariably wrong. Investors, who are able to exercise patience and discipline by adhering to a plan, are better able to inoculate themselves from the hyperbolic media and the panicking herd. Patience is having the understanding that market declines are only temporary; and the exercise of discipline is knowing that, in order to achieve positive returns, your portfolio has to experience negative returns from time to time.
1 Stock-Picking Mutual Fund Managers are Worse than We Thought at Beating the Market. Fortune. April 134, 2017
2 High Frequency Monitoring: A Short-Sighted Behavior. Betterment. September 16, 2014.