The 6 Biggest Mistakes Ordinary Investors Make
In many areas of life, we are often our own worst enemies. The realm of personal finance is no different.
What’s the biggest threat to achieving financial independence?
Unfortunately, it’s your own brain.
You can invest in all the right things, minimize fees and taxes, and even diversify your holdings. But if you fail to master your own psychology, it’s still possible to fall victim to financial self-sabotage.
The Brain’s Design
Today’s infographic is from Tony Robbins, and it uses data and talking points from his #1 Best Selling book Unshakeable: Your Financial Freedom Playbook, which is now available on paperback.
The graphic is based on a chapter in the book that reveals the key psychological limitations of the human brain. It turns out that these fallible survival instincts have been hardwired into our brains over millions of years, and they become very troublesome when we try to make rational financial decisions.
To overcome these instincts, investors need to adopt simple systems, rules, and procedures that can ensure the decisions around money we make are in our best long-term interest.
What I’ve found again and again is that 80% of success is psychology and 20% is mechanics.
– Tony Robbins
Six Psychological Pitfalls to Avoid
Remember these six pitfalls – and how to counteract them – and you’ll be able to avoid the biggest mistakes often made by investors.
Seeking confirmation of your own beliefs
Your brain is wired to seek and believe information that validates your existing beliefs. Our minds love “proof” of how smart and right we are.
Even worse, this is magnified by the online echo chambers of the modern world.
- News media (MSNBC, Fox News, etc.) tend to favor one point of view
- Google and Facebook filter our search results
- Unsubstantiated rumors can run unchecked, as long as they reinforce existing points of view
This can be exceptionally detrimental in investing.
Convincing yourself that a particular stock or strategy is correct, without taking into account contradicting evidence, can be the nail in the coffin of financial freedom.
The Solution: Welcome opinions that contradict your own
The best investors know they are vulnerable to confirmation bias, and actively ask questions and seek qualified opinions that disagree with their own.
Ray Dalio, for example, seeks the smartest detractor of his idea, and then tries to find out their full reasoning behind their contrary opinion.
The power of thoughtful disagreement is a great thing.
– Ray Dalio
Conflating recent events with ongoing trends
One of the most common – and dangerous – investing mistakes is to believe that the current trend of the day will continue.
In psychology speak, this is known as recency bias, or putting more weight on recent events when evaluating the odds of something happening in the future
For example, an investor might think that because a stock has performed well recently, that it will also do well in the future. Therefore, she buys more – effectively buying at a high point in the stock.
The Solution: Re-balance
Our memories are short, so what can we do?
The best way to avoid this impulsive and faulty decision making is to commit to portfolio allocations (i.e. 60% stocks, 40% bonds) in advance, and then re-balancing on a regular basis.
This effectively ensures you are buying low, and selling high. When stocks to well, you sell some of them to buy other assets in the underweighted part of your portfolio, and vice versa.
Very successful and driven people often assume they will be just as good at investing as they are at other aspects of their life. However, this overconfidence is a common cognitive bias: we constantly overestimate our abilities, our knowledge, and our future prospects.
The Solution: Get Real, and Get Honest
By admitting you have no special advantage, you give yourself an enormous advantage – and you’ll beat the overconfident investors that delude themselves in believing they can outperform.
If you can’t predict the future, the most important thing is to admit it. If it’s true that you can’t make forecasts and yet you try anyway, then that’s really suicide.
– Howard Marks
Swinging for the Fences
It’s tempting to go for the big wins in your quest to build financial wealth. But swinging for the fences also means more strikeouts – many which can be difficult to recover from.
The Solution: Think Long Term
The best way to win the game of investing is to achieve sustainable long-term returns that compound over time. Don’t get distracted by the short-term noise on Wall Street, and re-orient your approach to build wealth over the long term.
The stock market is a device for transferring money from the impatient to the patient.
– Warren Buffett
This psychological bias is known as “home bias”, and it is the tendency for people to invest disproportionately in markets that are familiar to them. For example, investing in:
- Your employer’s stock
- Your own industry
- Your own country’s stock market
- Only one asset class
Home bias can leave you overweighted in “what you know”, which can wreak havoc on your portfolio in some circumstances.
The Solution: Diversify
Diversify broadly, in different asset classes and in different countries. From 2000 to 2009, the S&P 500 only returned 1.4% per year, but foreign markets picked up the slack:
- International stocks: 3.9% per year
- Emerging markets: 16.2% per year
A well-diversified portfolio would have done well, no matter what.
Our brains are wired to bombard us with memories of negative experiences.
In fact, one part of our brain – the amygdala – is a biological alarm system that floods the body with fear signals when we are losing money.
The problem with this? When markets plunge, fear takes over and it’s easy to act irrationally. Some people panic, selling their entire portfolios to go into cash.
The Solution: Prepare
The best way to avoid negativity bias is to:
- Keep record of why you invested in certain securities in the first place
- Maintain the right asset allocation that will help you through volatility
- Partner with the right financial advisor to offer advice
- Focus on the long term, and avoid short-term market distractions
By failing to prepare, you are preparing to fail.
– Benjamin Franklin
These simple rules and procedures will make it easier for you to invest for the long term.
They’ll help you:
- Trade less
- Lower investment fees and transaction costs
- Be more open to views that differ from your own
- Reduce risk by diversifying globally
- Control the fears that could otherwise derail you
Will you be perfect? No.
But will you do better? You bet!
And the difference this makes over a lifetime can be substantial.
The Periodic Table of Investments
The investment universe is vast – but it’s also made up of many smaller components. See it all depicted in this nifty periodic table of investments.
Periodic Table of Investments
The investment universe is vast, but it’s also made up of many smaller moving pieces.
For serious investors, the foundation of the discipline is to understand the properties of these individual components, and to have them work in harmony to achieve a specific portfolio goal.
To do this successfully, one must understand the breadth of asset classes, tactics, and categories of investments that exist – and to know how they relate to one another.
The Chemicals Between Us
Today’s infographic comes from Phil Huber, the Chief Investment Officer for Huber Financial Advisors, who has cleverly depicted this relationship graphically in his blog.
Similar to how the physical universe is made up of chemical elements, he sees the possibilities around portfolio management as drawing from a broad pool of investing “elements”. Combine these different elements together, and you get compounds, structures, and eventually entire funds.
The periodic table of investments created by his team denotes each type of investment, the primary and secondary strategy related to it, and a color classification:
Here are the seven objectives that the top letters on each box refer to:
And finally, here are the colors that each block on the periodic table correspond to:
As you can see, considerable thought has been put into the categories and classifications. However, as Phil notes, this is simply the opinion of one person and it is not intended to be a universally accurate depiction of all portfolio management wisdom that exists:
I fully expect that there are a handful of omissions, or perhaps a few areas where one might flat-out disagree with how I’ve laid things out. This was not meant to be 100% exhaustive, nor was it meant to be indicative of what one of our portfolios looks like.
Phil Huber, Chief Investment Officer
For more of the lessons that can be derived from this clever periodic table of investments, we suggest checking out the original post on Huber’s blog.
Is there anything that he missed, or that you think could be classified better?
Here’s How to Become a 401(k) Millionaire
Millionaires are more common than you may think – here are the steps you need to take with your retirement investments to become a 401(k) millionaire.
Here’s How to Become a 401(k) Millionaire
There’s nothing more definitive in the journey to financial freedom than hitting the $1 million mark in retirement savings.
A nest egg like that is a near-guarantee that you could surmount any curveball the world throws at you, whether it is an unexpected family emergency or anything else.
While $1 million certainly sounds like a lofty milestone to many, it’s actually quite a common achievement:
- Millionaire households in the U.S.: 11.3 million (8.95%)
- Total households in the U.S.: 126.2 million
And contrary to popular belief, to become a 401(k) millionaire, you don’t need to strike it rich with a lucky stock pick, or use a crystal ball to forecast the future of the market.
Your best bet is to simply focus only on the factors you can control.
What You Can Control
Today’s infographic is from Tony Robbins, and it covers key points from his #1 Best Selling book Unshakeable: Your Financial Freedom Playbook, which is now available on paperback.
It shows that the biggest winners in the financial game know that they can’t predict the future, and instead titans like Warren Buffett or Jack Bogle focus intently on the factors they can control, knowing that with the right approach they’ll thrive in almost any market.
What are these crucial factors?
|Time||The force of compound interest is more powerful over longer periods of time.|
|Discipline||Staying calm and focused on the long term during periods of turmoil is key.|
|Diversification||Proper asset allocation and frequent re-balancing can position you to weather any storm.|
|Expenses||Expenses and taxes are silent killers, and must be minimized strategically.|
By diligently working to take control of these four factors, your odds of attaining financial freedom are extremely high. Here is each factor in more depth.
The power of compound interest is extraordinary, making time your best friend when it comes to building a battle chest of retirement savings.
The current maximum contribution limit for 401(k)s is $18,500 per year, not including what is matched by your employer. If you maxed out on contributions and started investing early, you can hit $1 million before retirement even in sub-optimal market conditions:
|Starting age||Required returns for $1 million at age 65|
Time can make up for a lack of investing acumen. Wait until later, and things get very difficult – by age 50, you need market beating returns!
If you’re taking advantage of the power of compound interest over a long period of time, whether that is 20, 30, or 40 years, it is inevitable that there will be bumps in the road:
- Stock market corrections happen once a year, on average
- Bear markets happen once in every 3-5 years, on average
- Bear markets vary in length, but on average last one year
Through decades of investing, the fact is you are going to see bear markets – it is how you handle them that counts.
Even when it’s the most tempting to sell, remember these facts:
- Bear markets become bull markets
- The first 12 months of a new bull market can see crucial market gains
- Nobody can successfully time the market – not even the experts
In other words, having the discipline to hold through the turbulence can be the difference maker – and a key factor you can control in your journey to becoming a 401(k) millionaire.
Another factor you control is portfolio diversification, and here are four ways diversification can minimize risk:
|Assets||Stocks, bonds, and alternative assets like real estate or gold.|
|Sectors||Consumer goods, tech, energy, financials, etc.|
|Markets||Domestic, international, emerging markets|
|Time||Add to investments regularly, because there is never a “right” time to buy|
A properly designed portfolio can weather any storm, and re-balancing it on a regular basis will force you to sell assets at market highs, while buying at low points.
The fees on your 401(k) statement might not seem like much, but even 1% or 2% can make a big difference over the long term.
For example: the value of $1 compounding for 50 years at 5% will be worth $11.50, but if it averages 7% it will be worth $29.50. That’s almost three times more!
Expenses, both seen and hidden, can be a silent killer any portfolio, so keeping them to a necessary minimum can help you get to the promised land.
A Final Word
If becoming a 401(k) millionaire was easy, everyone could do it.
But to be successful, you need to take control over factors like time, diversification, discipline, and costs – ideally with a qualified and experienced financial advisor and partner. Then, you need to stick to the plan and let the market do its work.
Investing is a game of inches. If your returns improve by, say, 2 or 3 percentage points a year, the cumulative impact over decades is astounding, thanks to the power of compounding.
– Tony Robbins
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