Hello! Before we dive in, I want to take a quick moment to introduce myself as a new Wealth Advisor at Creekmur Wealth Advisors here in Morton Illinois. I started my career in the industry with a company out of Colorado as a mutual fund/ETF wholesaler. From there I transitioned to TD Ameritrade and worked with retail investors in the Illinois.
During my time with both companies, I acquired a great depth of knowledge regarding common mistakes investors make consistently.
It is very common for investors to rely on tips they hear from co-workers, the news, or even family members. Some of the information received from these sources are reliable, but the majority is based on the source’s opinion with no real evidence to back it up.
Based on my experience, these are the three most noteworthy mistakes that investors make.
1. Timing the Market vs. Time in the Market
In my opinion, one of largest mistakes that investors make is trading based upon emotions. Negative news on the stock market or economy causes people to try to get in and out of investments and time the market for a quick gain.
There are many studies that track the performance of traders who actively maneuver in and out of the market and the correlating returns that they make. These studies show that this type of activity simply does not work. Studies show that 80%-90% of traders lose money when they try to actively trade. We all have heard of someone who has made a large gain on a trade, that is great. The problem is consistently sustaining that level of winning trades day after day, year after year.
The flip side of market timing is time in the market. Winthrop Wealth has a great study that shows a $10,000 investment in 1980 would increase to a shade over $1 million dollars at the end of 2020. The 30-year period had 10,000 trading days and assumed the individual never sells out of the S&P 500.
On the flip side, if the investor missed the best 20 days of this time frame the return would be cut from 12% to 8.3% which would total $270,000 from the $10,000 initial investment. If an investor missed 40 of the best days, the return would be cut in half to 6% and the original $10,000 investment would only be $110,000. Simply missing .02% and .04% of the 10,000 trading days results in a drastic decrease in return. Clearly, the most important determinant of investing success is time in the market versus timing the market. It’s not nearly as exciting, but the results sure do speak for themselves.
2. “The Market is Too High Right Now”
This is probably the most heard phrase during my time working in the retail community. I remember a particular client I encountered in the beginning of 2017 when the Dow Jones had just hit 20,000 for the first time. He would call in every few months about his cash balance in his account, it was around $100,000, and he was waiting for the right time to invest it.
We discussed the pros and cons of dollar cost averaging and lump sum investing, but every time he ended our conversation with “the market is too high to invest right now”. We stayed in contact throughout the year and every time we spoke that year the market was higher, and he muttered the same words he always did. After one year had passed the Dow was at 25,000 and he surely said the same thing again. We even had a downturn in January 2018, and it was lower than the 25,000 and he still wouldn’t pull the trigger because he felt the market was too high.
Fast forward a few years to 2020 with the index hovering around 28,000 and you guessed it, the market was still too high to invest in. Finally, in 2021 the Dow hit 30,000 and he still had that $100,000 sitting in cash. That was when he finally realized that he had made a mistake by letting it sit there.
The phrase “all time high” is not a rare occurrence. In 2019 and 2020 there were anywhere from 30-40 all-time highs each year. This number jumped to 68 record high closes in 2021 (the most in 26 years). History shows the market has continually moved up over time, but he let his own opinion get in the way of making a smart financial decision. A clear financial plan can help overcome this emotional thinking, the market will go up and down, but long-term goals should not be overlooked due to emotion.
3. Holding onto Losing Positions
Many people who manage their own investments are guilty of making a bad investment, myself included. Whether it was a bio tech company you heard about from a friend or a cutting-edge technology tip you saw scrolling online, some companies simply do not make it for one reason or another. What can make this situation worse is when an investor does not want to sell and make that loss on a computer screen real. They hold their investment in hopes the stock will eventually make it back to break even.
I have had many clients who refused to sell the position they were holding at a substantial loss. Some would be down 60% and some would even be down 95% and they all shared the same belief - that the stock will either come back or they would rather it go to zero instead of recognizing a bad investment and sell out at the current loss.
This is an example of a cognitive error described in behavioral finance as loss aversion. Loss aversion states that investors are so fearful of losses that they shift their focus to trying to avoid realizing a loss rather than making a gain with a better investment.
It’s important to keep in mind some basic arithmetic of investing. If you lose 50% on an investment you need to make a return of 100% over time in order to get back to break even. However, on an 80% loss, the return must be 500% in order to get back to break even. People must accept that it is time to move on from the position and stop hoping for a recovery in order to avoid compounding losses rather than gains.