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The 6 Biggest Mistakes Ordinary Investors Make

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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.

Mistake #1:

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

Mistake #2:

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.

Mistake #3:

Overconfidence

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

Mistake #4:

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

Mistake #5:

Staying Home

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.

Mistake #6:

Negativity Bias

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

Conclusion

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.

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Mining

How to Avoid Common Mistakes With Mining Stocks (Part 3: Jurisdiction)

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Mining Jurisdictions

“Location, location, location…”

This famous real estate adage also matters in mining. After all, it’s an industry that is all about the geology—but beyond the physical aspects and the location of a mineral deposit, there are also social and environmental factors that create a mining jurisdiction.

Common Mistakes With Jurisdiction

We’ve partnered with Eclipse Gold Mining on an infographic series to show you how to avoid common mistakes when evaluating and investing in mining exploration stocks.

Part 3 of the series focuses on six signals investors can use to gauge a company’s preparedness for the jurisdictions they operate in.

jurisdictions

View the two other parts of this series so far, covering mistakes made in choosing the team as well as those made with a company’s business plan.

#1: Geological Potential: Methodical Prospecting or Wild Goose Chase?

It all starts with a great drill result, but even these can be “one-off” anomalies.

Mineral exploration is a methodical process of drawing a subsurface picture with the tip of a drill bit. A mineral discovery is the cumulative effort of years of research and drilling.

The key to reducing this geological risk is to find a setting that has shown previous potential and committing to it. Typically, a region is known to have hosted other great discoveries or shares a geology similar to other mining districts.

Signs of Methodical Prospecting:

  • Lots of geological indicators
  • Potential for further discovery
  • Sound science

#2: Legal Environment: Well-Paved Path or Minotaur’s Maze?

Now that you have identified a region with the prospective geology you think could host a discovery, a company will have to secure the permits to explore and operate any further.

However, a management team that cannot navigate a country’s bureaucracy will face delays and obstacles, costing investors both time and money.

Without clear laws and competent management, a mining company’s best laid plans become lost in a maze with legal monsters around every legal corner.

Signs of a Well-Paved Highway:

  • Existing laws encourage mining investment
  • Relatively low bureaucracy
  • Well-established permitting process
  • Legacy of mining contributing to economy

#3: Politics: Professional Politics or Banana Republics?

A good legal framework is often the outcome of politics and stable governance—however so is a difficult legal framework.

The political stability of a nation can turn on one election and so can the prospects for developing a mine. An anti-mining leader can halt a mining project, or a pro-mining leader can usher forward one.

A positive national viewpoint on mining may be enough to lure investment dollars, but local politics may determine the success of a mining company.

Signs of Professional Politics:

  • Positive history with mining companies
  • Politically stable jurisdiction
  • Rule of law respected
  • Changes in government have little effect on the mining industry

#4: Infrastructure & Labor: Modern or Medieval

Sometimes it is the discovery of valuable minerals that spurs national development, but this can also happen the other way around, in which development can encourage mineral discovery.

A mining company looking to build a new mine in a country with a tradition of mining will have an easier time. Access or lack thereof to modern machinery and trained employees will determine how much money will be needed.

That said, if a company is looking to develop a mining project in a new mining region, they must be ready to help create the skills and infrastructure it needs to mine.

Signs of a Modern Jurisdiction:

  • Developed roads to access and support operations
  • Trained labor for staffing and development
  • Well-established grid lines and back-up power systems

#5: Community: Fostering Friendship or Sowing Enemies

Mining operations have a significant impact on the local community. Good companies look to make mutually beneficial partnerships of equals with local communities.

Ignoring or failing to respect the local community will jeopardize a mining project at every stage of its mine life. A local community that does not want mining to occur will oppose even the best laid plans.

Signs of a Friendly Relations:

  • Operations bring community together
  • Local history shows support for mining
  • Understanding of local concerns and regional variety
  • Company contributes to economic growth and health of the community

#6: Environment: Clean Campsite or One Night Party

There is no way around it: mining impacts the environment and local ecosystems. But, mining operations are a blip on the radar when it comes to Earth’s timeline.

Mine sites can again become productive ecosystems, if a company has the capacity and plan to mitigate mining’s impacts at every stage of the life of a mine—even beyond the life of a mine.

Signs of a Clean Campsite:

  • Development plan mitigates environmental damage
  • Well-planned closure and remediation
  • Understand how communities use their environment

Bringing it together: ESG Investing

These six points outlined above point towards a more complete picture of the impacts of a mining project. Currently, this falls under what is labeled as Environmental, Social and Governance “ESG” standards.

Mining companies are the forefront of a big push to adopt these types of considerations into their business, because they directly affect natural and human environments.

ESG is no longer green wash, especially for the mining industry. Companies that understand and apply these concepts in their business will have better outcomes in the jurisdictions they operate within, hopefully offering investors a more successful venture.

Geology does not change on the human time scale, but bad management can quickly lose a good project and investor’s money if they do not pay attention to the other attributes of a jurisdiction.

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Technology

By the Numbers: Are Tech IPOs Worth the Hype?

Technology IPOs draw massive investor and media attention, sometimes raising billions of dollars. But do tech IPO returns match up with the hype?

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Tech IPOs Shareable

Tech IPOs — Hype vs. Reality

Initial Public Offerings (IPOs) generate massive amounts of attention from investors and media alike, especially for new and fast-rising companies in the technology sector.

On the surface, the attention is warranted. Some of the most well-known tech companies have built their profile by going public, including Facebook by raising $16 billion in 2012.

But when you peel away the hype and examine investor returns from tech IPOs more closely, the reality can leave a lot to be desired.

The Hype in Numbers

When it comes to the IPOs of companies beginning to sell shares on public stock exchanges, tech offerings have become synonymous with billion-dollar launches.

Given the sheer magnitude of IPOs based in the technology sector, it’s easy to understand why. Globally, the technology sector has regularly generated the most IPOs and highest proceeds, as shown in a recent report by Ernst & Young.

In 2019 alone, the world’s public markets saw 263 IPOs in the tech sector with total proceeds of $62.8 billion. That’s far ahead of the second-place healthcare sector, which saw 174 IPOs generate proceeds of $22.5 billion.

The discrepancy is more apparent in the U.S., according to data from Renaissance Capital. In fact, over the last five years, the tech sector has accounted for 23% of total U.S. IPOs and 34% of proceeds generated by U.S. IPOs.

tech-IPOs-Supplemental

The prevalence of tech is even more apparent when examining history’s largest IPOs. Of the 25 largest IPOs in U.S. history, 60% come from the technology and communication services sectors.

That list includes last year’s well-publicized IPOs for Uber ($8.1 billion) and Lyft ($2.3 billion), as well as a direct public offering from Slack ($7.4 billion). Soon the list might include Airbnb, which plans to list within the communication services sector instead of tech.

The Reality in Returns

But the proof, as they say, is in the pudding.

Uber and Lyft were two of 2019’s largest U.S. IPOs, but they also saw some of the poorest returns. Uber fell 33.4% from its IPO price at year end, while Lyft was down 35.7%.

And they were far from isolated incidents. Tech IPOs averaged a return of -4.6% last year, far behind the top sectors of consumer staples (led by Beyond Meat) and healthcare.

SectorAvg. IPO Return (2019)
Consumer Staples103.0%
Healthcare35.9%
Financials30.8%
Materials30.4%
Consumer Discretionary14.6%
Industrials6.1%
Energy-0.4%
Technology-4.6%
Utilities-7.8%
Real Estate-9.4%
Communication Services-66.4%

While last year was the first time tech IPOs have averaged a negative return in four years, analysis of the last 10 years confirms that tech IPOs have underperformed over the last decade.

A decade-long analysis from investment firm Janus Henderson demonstrated that U.S. tech IPOs start underperforming compared to the broad tech sector about 5-6 months after launching.

This dip likely corresponds to the expiry of an IPO’s lock-up period—the time that a company’s pre-IPO investors are able to sell their stock. By cashing in on strong early performance, investors flood the market and bring share prices down.

Interestingly, most gains for these IPOs tend to happen within the first day of trading. The median first-day performance for tech IPOs was a 21% increase over the offer price. That’s why the median first-year return for a tech IPO, excluding the first day of trading, is -19% when compared with the broader tech sector.

How to Make Money from Tech IPOs

So does that mean that investors should avoid tech IPOs? Not necessarily.

Longer-term analysis from the University of Florida’s Warrington College of Business shows that U.S. tech IPOs offer better returns than other sectors as long as investors get in at the offer price.

U.S. Tech IPO Returns from Offer Price

SectorAvg. Three-Year Return Market-adjusted Return
Tech77.0%28.3%
Non-Tech34.6%-11.4%

Even when adjusting for the broader market performance, tech IPOs have been solid in comparison to the offer price.

The challenge is that if investors are buying stock after that first day market bump, they may have already missed out on meaningful gains:

U.S. Tech IPO Returns from First Closing Price

SectorAvg. Three-Year Return Market-adjusted Return
Tech46.1%-2.7%
Non-Tech23.7%-22.2%

So should investors shy away from tech IPOs unless they’re able to get in early?

Generally speaking, the analysis holds that new tech companies perform relatively well, but not better than the broader market once they’ve started trading.

However, in a world of billion-dollar unicorns, there are always exceptions to the rule. The University of Florida study found that tech companies with a base of over $100 million in sales before going public saw a market-adjusted three-year return of 24.4% from the first closing price.

If you can sift through the hype and properly analyze the right tech IPO to support, the reality can be rewarding.

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