Three Investing Mistakes to Avoid
Published On: August 18, 2021
Written by: Ben Atwater and Matt Malick
Obviously, this is not an exhaustive list of investing errors, merely a short summary of three significant mistakes all of us are tempted to make. We will note that most investors feel extreme temptation to make these mistakes. Being aware of these weaknesses is half the battle, while avoiding them is the other half. Although we have succumbed to all these mistakes before, we work hard to avoid making them again.
A trader following a macro strategy bases decisions primarily on an overall view of economic and political environments, i.e., macroeconomic perspectives.
During the financial crisis, the most popular macro stance was the idea that easy monetary policy would create rampant inflation. For 13 years, this view was wrong. We are only now, as of this writing, starting to see any signs of inflation arise in the consumer price index (CPI).
If you made an investment that would profit from inflation back then, it would have been a very long wait and a lot of missed opportunities until today.
The failure of this thesis points to the fact that macro investing is simply guesswork. The world is too big, complicated and uncertain to accurately predict the future macroeconomic environment.
As another example, many investors, especially professionals, have been unwilling to commit to fixed income (bonds) since the financial crisis for fear of higher interest rates, which hurt bond prices.
Anecdotally, we have seen institutional investors consistently underweight bonds for years, instead opting for alternative asset classes. Yet as we sit here now, global interest rates continue to remain far below normal levels and bonds have extended their multi-decade bull market run further than anyone ever predicted. All the while, alternatives have generally performed poorly.
Bottom line, it is far better to have a comprehensive financial plan that informs your investment decisions rather than trying to make sense of a highly unpredictable world. Owning individual stocks and bonds is invaluable because well-run companies adapt to constantly changing environments and high-quality individual bonds provide steady cash flows and a hedge against stock market volatility.
Big and/or Quick Profits
The potential upside of any investment idea – a hot new technology, a “proven” trading strategy, an incredibly cheap security, a fast-growing stock, a meme stock, or a crypto currency – is almost always trumped by the potential downside. But in the fog of excitement and perceived certainty, the pitfalls are difficult to process. Put another way, investments that have the potential for huge upside also have the potential for huge downside.
In our stock selection discipline, we should feel confident estimating a company’s long-term rate of return based on dividend yield, conservative estimates of earnings and dividend growth, and price-to-earnings multiple changes based on historical average valuations. Using this technique, we look for companies that we anticipate can increase in value over the long-term at an 8% to 12% average annual rate. Therefore, we aim to avoid “hot stock” ideas where we speculate that we can make a quick or outsized profit.
In one of our more egregious mistakes, after an exhaustive due diligence process, we purchased shares in a company that we believed was worth many times its share price. Although we might have been correct if not for the collapse of oil prices back in 2014, the investment turned sour. This error made us even more aware of the importance of getting on base versus swinging for the fences. Strikeouts hurt a lot worse in investing than in baseball.
After more than twenty years of investing, we have seen three bear markets (the dot com crash, the financial crisis and COVID-19). We have also seen three robust bull markets (late 2002 through 2007; 2009 through early 2020; and mid-2020 to now). Barely anyone saw any of these coming.
In the process, we have read a myriad of expert opinions, forecasts and analysis. We have concluded that, much like meteorologists, stock market forecasters are sometimes right and often wrong. But the accuracy of their forecasts is overwhelmingly driven by pure luck. It is no accident that the most famous stock market forecasters are either permanently bullish or permanently bearish – after all, as the saying goes, a stopped clock is right twice a day.
The next bear market could begin with stocks trading at twenty times earnings or with stocks trading at fifty times earnings. It could start for any reason and at any time. It could come tomorrow, or we may not see it for many more years.
We would never even consider trying to time the next bear market by selling stocks. Rather, we plan to stick to a discipline of setting appropriate asset allocation targets, reevaluating these targets as clients age and personal circumstances change, reinvesting cash in underperforming securities and rebalancing after major multi-year moves in the market.
The most important thing you want in investing is an experienced and disciplined approach – a process that slowly evolves based on experience, not based on overconfident market predictions. Furthermore, you want investing that focuses on doing the little things right and being aware of the pitfalls of doing big things wrong.