3 Big Mistakes Most Investors Make and How to Avoid Them

1. Procrastination

There are many variables in investing, unfortunately time is not one of them. Yes, you can extend when you are planning on retiring, or fulfilling a goal, but you cannot go back to when you should have started saving. We’ve all heard the saying “the best time to invest is 30 years ago, the next best time is now.” The truth in that saying is due to one principle: the power of compound interest. Compound interest is simply when your gains start earning gains. At that point your original investment isn’t the only money working for you. There is a snowball effect that takes place and accumulates over time. The problem is, often times we see these returns and then we hear about other returns that might be better, and we get greedy. At that point we start to make mistake number two.

2. Chasing Returns

We’ve all seen the headlines in Money Magazine “Best 100 Mutual Funds”. At conferences I’ve been told that magazine sales skyrocket when these titles appear on the cover. Everyone reads that XYZ fund has done 25% over the last 3 years. But what they don’t see is that investor return and fund return are not always the same.

Investors who buy on advice from friends or magazine are constantly chasing the hottest funds for high returns. When the fund doesn’t perform as well as its past performance, they sell and move on to the next magazine’s “hot” picks. I recently sat through a presentation for advisors from a well known investment research company whose name I cannot mention, that reinforced my thoughts on this topic. While I’m not allowed to mention data from this presentation because it has not been approved for public use, I have found a recent article from Kiplinger magazine citing data from Morningstar that says “Investors earnings are often far less than funds’ reported gains, particularly with volatile funds.” The article “Your Real Total Return” does a wonderful job of illustrating a point many of us in the industry fight clients about when markets get hot.

VOLATILE FUNDS SYMBOL 5-YR ANNUALIZED FUND RETURN 5-YR ANNUALIZED INVESTOR RETURN
CGM Focus CGMFX 23.4 14.3
Royce Value Service RYVFX 19.3 3.1

SEDATE FUNDS SYMBOL 5-YR ANNUALIZED FUND RETURN 5-YR ANNUALIZED INVESTOR RETURN
Jensen Portfolio JENSX 5.7 5.3
Selected American Shares S SLASX 9.7 9.7

It is generally agreed that asset allocation, or the choice of which assets you invest in, account for most (upwards of 95%) investment return. This was first discovered in an unprecedented paper published in 1986 called “Determinants of Portfolio Performance,” by Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower. The funds you use to make up your asset allocation should have decent return, and according to the Kiplinger article, low volatility to prevent investor anxiety.

3. Pay too much

Over time, lower expenses can lead to greater return. I’m not the only one who believes this theory. John Bogle, founder of Vanguard says “the shortest route to the top quartile in performance is to be in the bottom quartile of expenses .” He should know; of the 57 funds around from 1981 to 2001, his fund, the Vanguard 500 Index Fund, was tied for the 7th best performer over that time period. (Source: All About Index Funds by Rick Ferri.) For those chasing returns, the trick would’ve been choosing one of the seven funds that beat the Vanguard Fund, AND holding it for 20 years. This feat is probably too much to handle for someone swayed by magazine headlines.

So how does one avoid making these 3 big mistakes?

The best way to prevent procrastination is to have a plan. Studies suggest that having a written investment plan increases your chances of having more money at retirement. A plan gives you focus and accountability. You can reference it over time to see how you are doing, and if necessary, make adjustments along the way.

Avoid chasing returns by putting your faith in an asset allocation that has worked under historical conditions. Remember that asset allocation accounts for over 90% of return. While it may be tempting to chase fund return, the odds are against you.

Keep your costs low by choosing an allocation in low cost index funds. They will never give you the stellar returns we read about, but because of low expense ratios, over time your returns will keep you from falling in the bottom quartile. So maybe you don’t get “the best” returns. Consider the difference an investment in peace of mind.

Rich Feight is a Fee-Only Certified Financial Planner and founder of IAM FInancial, LLC in Michigan. He is also the author of Thinking Beyond Numbers, the financial planning and investment blog that brings awareness to your financial habits so that you can make good decisions. You can learn more about Rich at IAM FInancial, LLC.

About the author

Richard T. Feight, CFP®
Richard T. Feight, CFP®

Among independent financial advisors, Mr. Feight is one of the most well known and highly respected “Fee-Only” financial planners. Since 1997, Rich has dedicated his career to offering low cost “Fee-Only” comprehensive financial planning and investment advice. Rich assists his clients in organizing their finances so that they can retire on time.Rich is a graduate of Michigan State University where he received his degree in Finance. Rich has earned the Certificate of Financial Planning from The College for Financial Planning in Denver , Colorado that was comprised of intense graduate level classes grounding him in the various foundations of financial planning. He is a CFP® (Certified Financial Planner®) since 2001, meeting the experience, education requirements and passing the two-day, 10 hour exam, making him one of the few in the country who hold the designation. Since 2003, Rich has subscribed to the stringent and mandatory annual educational hours, experience, and code of ethics to meet the requirements to be a NAPFA Registered Financial Advisor. Out of the 800,000 individuals in the country who claim they are financial advisors/planners, fewer than 1,300 in the country qualify for the membership; Rich is one of them.

Rich is the President of the Financial Planning Association (FPA) of Michigan . The FPA of Michigan is one of largest and influential chapter in the country. Rich was recently named President for Transportation Toastmasters Club 4776 downtown Lansing . He has been quoted in both local and national media from Noise Magazine to CNBC, and Bloomberg, and industry news publications such as Investment News and Financial Advisor Magazine. Rich enjoys public speaking and has spoke at industry educational meeting, high schools, and executive investment clubs, AARP conferences, and business educational seminars for companies looking to educate their employees. Rich views his role as a Fiduciary for his clients as the single biggest key to any planning relationship and strives to provide the most competent, unbiased and objective advice in the financial planning profession today.

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