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15 of the Biggest Investing Mistakes and How to Beat Them

Just five investing rules will help you beat some of the biggest investing mistakes to reach your financial goals

So we’ve seen time and again that the average investor return sucks. DALBAR data shows a return of 4.7% for the average investor against 8.2% market returns over the 20 years through 2015.

And investors don’t just suck at picking stocks. Research also showed that bond investors averaged just 0.5% annually against bond returns of 5.3% over period.

What happened? What are the biggest investing mistakes people make when it comes to putting their money to work?

How can we learn from these mistakes and become better investors?

This post will look at the 15 most common investing mistakes that lose money. We’ll look at emotional and behavioral mistakes in investing as well as some that nearly everyone makes.

I’ll then show you five investing rules you can use to avoid making these mistakes and how to reach your financial goals.

More Clues on Investor Mistakes

Before we get to that, some more information on investor mistakes will help shine a light on what investors are doing that loses so much money.

The data further shows that 44% of the difference in returns is due to panic-selling when markets are falling. So, almost half of the difference between market returns and those earned by the average investor are because of jumping out of stocks at the wrong time.

Another 15% is due to holding on to too much cash well after stocks have started to rebound. I can fully understand this one. You’ve just seen your stock portfolio destroyed, falling 50% from the market top. You cut your losses by selling before it got any worse and now the market starts to move higher.

But who knows if this is the beginning of a bull market, taking stocks to new highs, or if the market crash is just taking a breather before heading lower. So you wait to buy stocks again. And you wait and wait until you’ve missed out on much of the rebound.

Another 19% of the difference between market returns and those earned by the average investor is from not being invested for some reason. A lot of times this is from job loss or emergency spending that forces you to cut back on investing and miss out on market gains.

Finally, fees account for another 22% of damage due to over-trading on bad behaviors and frequent stock buying.

biggest investing mistakes that lose money

Biggest investing mistakes and why investors lose money.

To recap the investing actions that lead to poor stock market returns:

  • Panic-selling, selling low when stocks have tumbled
  • Waiting to buy back into the market after a stock market crash
  • Not investing regularly
  • Buying and selling frequently, causing fees to add up

Now that we have an idea of some of the investing actions that lead to poor returns, let’s look at some of the behaviors and mistakes that lead to these actions.

Biggest Behavioral Mistakes in Investing

The majority of investor mistakes can be traced back to behavioral and emotional investing. In fact, behavioral problems in investing is such an important topic that it’s an entire course on many college campuses.

It makes sense. Money can’t buy happiness but try reaching many of your life goals without it. We work hard for our money and it shouldn’t be a surprise if we get emotional when it grows quickly or plunges to zero.

But all those instincts and urges, all those fears and hopes that help you in other situations end up causing you money when it comes to investing. You are truly your own worst enemy when it comes to investing.

Let’s look at the ten most common behavioral mistakes in investing and why we just can’t help ourselves. Don’t worry if it starts to seem overwhelming, we’ll cover some investing rules that will help you stay on track and control those investing urges.

Mental Accounting is when you split your investments into different groupings and then take different risks within each group without a whole-portfolio view. I see this a lot when investors try investing in a bucket approach.

One common bucket strategy is to split your investments into two buckets or accounts. In one account, you invest for your must-have goals like basic needs in retirement spending. Since reaching your goals here are absolutely critical, you invest super-conservatively with this money.

In the other account you invest money for nice-to-have goals, things you’d like to do in retirement but could live without. Since reaching these goals isn’t something that would make or break your retirement, you invest aggressively with risky stocks. The thinking is that you can take on a lot of risky investments in this account because it won’t matter as much if you don’t reach the goals.

The problem is that people end up taking on too much risk in the second bucket, investing in penny stocks and trying to beat the market. They end up losing money and not reaching their nice-to-have goals. But they also invest too conservatively in their first bucket, investing only in bonds and not enough in risky investments. They end up missing their must-have goals as well!

Your investing plan should be on a whole-portfolio basis. You can have different investing accounts but you need to understand how all your investments fit together to meet all your goals.

Following the Crowd is one of the biggest investing mistakes I see among clients. There’s a sense of security in the crowd, right? If there was something wrong with what the crowd was doing, somebody would say something, right?

investor mistakes following the crowdThis sense of security even causes problems for financial advisors and equity analysts. A lot of advisors believe unquestionably in market prices. They reason that there are so many investors, all buying and selling on the same information, that the market price for a stock must be correct.

Believing this infallibility of the market means you can’t do any better than the market. If stock prices are always fair then just buy the entire market index.

Tell that to the investors that lost half their portfolio in the crashes of 2000 and 2008. Pardon me if I think sometimes the stock market acts like a mental patient off their meds…and that’s not the kind of crowd I want to follow.

Following the crowd also makes us more susceptible to outright scams. Bernie Madoff scammed millionaires out of billions of dollars through a network of referrals. At the trial, investors testified that they thought something was fishy but figured nobody else made any complaints so Madoff must be on the level.

Fear of missing out is a behavioral mistake I see every time stocks start moving higher. Investors hear about some stock doubling or tripling in price and don’t want to miss out on the potential to become rich overnight. They jump into the stock, investing thousands, and then end up losing money when the price comes back down to earth.

The investing media is a huge cause of this one. Understand that most investing TV shows and a lot of websites are there FOR ENTERTAINMENT PURPOSES ONLY. Viewers pay the bills through advertising so these shows find the most exciting and interesting story available and what’s more exciting than hearing about a stock that has jumped ten-fold in a year?

If you are going to pick individual stocks, don’t do it on the basis of what the share price has done in the past. That past performance has absolutely nothing to do with what the stock will do in the future. The only thing that will keep that share price moving higher is a good business model and strong financials.

Anchoring is the over-reliance on previous information. That’s a complicated way of saying we stick to our first impressions not only about people but it turns out in stocks also.

Even stock analysts fall for this one, doing weeks of research on a company to form an opinion. When something happens that changes the company’s future, they don’t give it the attention it deserves. They stick to their previous information, even if it doesn’t reflect the company’s new direction.

I see this a lot reading analyst reports about management at a company. They build this view of management as great leaders that will guide the company to higher profits and recommend investing in the stock. Changes in management or new information that contradicts the initial view is ignored. The stock price plunges but the analyst can’t seem to change their recommendation to reflect the new reality.

Understand why you invest in each of the companies in your portfolio, to the point of making a list of reasons. If something changes that contradicts those reasons, don’t let this behavioral bias keep you from changing your mind on the stock.

Confirmation bias is a really interesting behavior. I think a lot of these behavioral biases are interesting but confirmation bias especially because we see it in so many parts of our lives.

how to avoid biggest investing mistakesConfirmation bias is only looking for or being receptive to views that support your own.

It’s most obvious in political views so I’ll use that as an example. Think of the websites or TV channels you watch for news. If you consider yourself a conservative or closer to the Republican side of the aisle, you’re more likely to watch Fox News or RealClearPolitics. If you consider yourself a liberal or closer to the Democrats’ side of the aisle, you’re more likely to watch MSNBC or The Guardian.

We are much more likely to click through and read an article when the headline supports a previous viewpoint. We’re much more likely to surround ourselves with people that hold the same views and beliefs.

The problem in investing, well the problem in general, is that confirmation bias keeps you from being objective. You think you’re getting all the facts about a viewpoint but you’re really only getting one side of the story…because subconsciously that’s all you’re open to seeing.

Any investment you own, whether it’s something you’re considering buying or have held it for a long time, you have to be willing to hear both sides of the story. Not only that, but to balance your natural tendency to seek out confirming evidence, you have to actively seek information contrary to your opinion. You have to look for people with the opposite opinion and really try to see their side of the story.

Loss aversion loses more money than any other behavioral mistake. Loss aversion is the reluctance to sell a losing investment even while you quickly sell your winners to take the profit.

Studies show that people feel the pain from loss as much as 2.5-times more strongly than the happiness they feel from winning. Losing sucks and people will do almost anything to keep from feeling that pain.

In investing, that means not selling stocks that are clearly not good investments. Even when investors change their mind on a stock that has suffered losses, they hold on to the shares in the hope to break even. They will hold onto a bad investment because selling would make the loss real, whereas holding on means there’s always a slim chance the stock can recover.

Hindsight bias is a funny one to watch for, especially when listening to pundits on TV. You’ve probably heard the phrase, “Hindsight is 20/20,” which means it’s always easy to see the mistakes of the past.

Hindsight bias is thinking all the clues to that past behavior or event were obvious. We look back at the housing bubble and say, “Well, yeah. Of course it was all going to come crashing down. Look at all the facts.”

Looking back at these past events, people start to think clues to future events will be just as obvious.

On TV, this usually happens when pundits try to forecast the stock market by comparing it to previous periods. They’ll point to all kinds of technical indicators or find the slightest similarity in comparisons to make their forecast.

In individual investors, we see hindsight bias a lot in the belief that investors can take a lot of risk while the market is going up because they’ll be able to see the ‘signs’ before the next stock market crash. It’s the belief that, because the signs were so seemingly obvious in the past, that they’ll be obvious in the future.

Of course, the fact is that nobody saw the signs before the previous stock market crashes in the past either. They only seem obvious in hindsight.

Familiarity bias is the preference for things we know or think we know. People may say that ‘opposites attract’ but we’re actually attracted to the things that are most familiar, the things that are more similar.

In investing, you see this in the fact that most Americans invest almost exclusively in American companies. More than that, most people hold most of their stocks in very large companies they see and hear about on a regular basis.

Many investors also have a large percentage of their wealth tied up in shares of their employer. They feel like they ‘know’ the company and that assurance makes for an easy excuse to own the stock.

The problem is that this kind of thinking leaves an investor with huge risks in their portfolio. Holding only stocks of large American companies means you’re totally at the mercy of the next U.S. economic recession.

Worse still, holding too much of your wealth in shares of your employer risks losing your nest egg at the same time you lose your job. That might seem like an extreme example but what if low corporate profits cause the company to cut back on raises. The company’s share price could plunge just as your salary flatlines for years.

Rules-based investing will help avoid most of these bad investor behaviors but especially when it comes to familiarity bias. By setting rules about how much stock you own in one company or about investing across different regions or company size, you can make sure you spread your risk out more evenly.

Self-attribution bias is a painful one to watch in friends and family. This is the tendency to look at successes as coming from your own behavior while losses are something that were uncontrollable or not your fault.

Put another way, someone may see all their problems as uncontrollable and not their fault. They don’t seem to make a connection that it was their actions that led them down that path. It’s always someone or something else that’s doing it to them, not something they’ve done or haven’t done.

In investing, someone might think they picked a winning stock on their skill as an investor while a losing stock lost money for reasons that were beyond their control or unforeseeable. They blame losses on the economy or politics or anything but their analysis while earnings are always chalked up to skill.

After a while of this, the investor gets an inflated sense of their own ability as a stock picker. They start investing in riskier stocks, because they really know how to pick winners. Of course, they don’t see the losses piling up and their average return is less than great.

Overconfidence is another behavioral investing bias that can hit your portfolio without even knowing it. The idea is that, with more experience in investing, the investor starts to overestimate their own ability in picking stocks. This overconfidence leads to risky behaviors like investing more in stocks than is appropriate.

Like most of the other behavioral mistakes, you see this one in other parts of life as well. In a survey on driver behavior, 80% of drivers rated themselves as above-average drivers. Now think about that. The idea of an average is that about half of the population is above that point and half are below it.

So it can’t be the case that eight-in-ten drivers are all above average…it’s just how they think of themselves.

Overconfidence is a tough bias to beat. It’s good to learn more about investing or personal finance or whatever you’re doing. Knowledge is a good thing but you also need to understand the limits to what you know.

Those are some of the most common behavioral biases that cause us problems in investing. A lot of these have become hard-wired in our brains to help us deal with so many things in life. They may help to understand the world around us but they also leave us at risk of making mistakes with money.

Other Common Mistakes in Investing

There are a few more common investing mistakes that don’t quite fall into the behavioral problems. You might see a behavioral bias in them but I wanted to call them out separately because they account for a good deal of the bad investments I see with clients.

Trend chasing is believing future returns for a stock or fund will behave like past returns. Admit it, where is the first place you look when you look at a mutual fund or ETF? I know I look at the three-, five- and ten-year annual return.

But relying on past returns to decide in which funds to invest can be dangerous, especially after eight-years of a bull market. Annual returns of double-digits on mutual funds are making it look like portfolio managers have a crystal ball for making money. Their skill may be over-rated if you compare it to a 16% annualized return on the S&P 500 since the 2009 stock market low.

Overreliance on stocks is a common problem in most portfolios. Most investors, especially younger investors, should probably have most of their portfolio in stocks to take advantage of higher, long-term returns but you should always have investments in other assets as well.

Investing part of your portfolio in bonds will not only protect your portfolio from a stock market crash but also gives you a ready source of cash to take advantage of lower stock prices. As you get older, bonds will also provide a safe cash flow to pay living expenses.

Investing in real estate through REITs and real estate crowdfunding gives you returns comparable to stocks while benefiting from diversification. As a physical asset, real estate is excellent protection against inflation and provides a source of cash flow from rents.

Overreliance on TV/internet advice is an easy one to understand. You’re busy. You have a life and don’t want to spend hours putting together and watching an investment portfolio.

That’s what CNBC or a thousand internet websites are there to do, right?

So the average investor switches to their favorite money channel or website once a month to get a few stock picks. They buy whatever the pundits say look good and that’s all there is to it.

There are two problems with just relying on the financial media to pick your investments.

  1. That’s not an investment strategy, just a collection of stock picks. Rarely do most websites talk about putting together your personal investing plan and matching your investments to your needs. This is one of the most important steps in investing and something you need to do before picking stocks.
  2. The financial media isn’t about picking good investments. It’s about entertainment and making investing exciting enough that you come back to watch more. Pitching risky investments for spectacular gains is how they grow ratings…even if it drains your nest egg.

Catching a falling knife is a saying in investing for when an investor keeps putting money in a falling stock. From the investor’s point-of-view, they’re buying a good stock at a better price every time the stock gets cheaper.

The reality is that the investor might be sinking too much money in a company that may never recover.

Buying a stock as its price tumbles is tempting. What might have looked like a good buy at $50 must be a screaming deal at $25, right? Earlier investors are tempted to buy more shares at the lower price so their average price per share is lower and the stock won’t have to recover all the way to break-even.

You’ll hear it called ‘dollar-cost averaging’ by some investors but it can be a very dangerous strategy…as dangerous as trying to catch a falling knife.

The problem isn’t in buying more shares in the company. It might still be a good long-term investment. The problem is in chasing the stock down and continuously buying more shares.

I know an investor that got caught in the coal company bankruptcies a few years ago. Cheap natural gas and government regulations were killing coal miners. He figured the strongest company in the industry, Peabody Energy, could outlast the tough times so he kept buying shares from $225 to $150 to $40 and lower.

It wasn’t long before he had more than half of his entire wealth invested in the company, praying that the shares would recover. They never did and Peabody filed bankruptcy, taking $30,000 of his money with it.

It’s ok to buy more shares of the companies in your portfolio. If the share price declines but you feel it’s still a good investment then dollar-cost averaging is an acceptable long-term strategy. Be careful though that you don’t follow it too far, putting more than 5% of your portfolio in any single stock.

Following stocks rather than your own goals is kind of an over-arching problem from a lot of these mistakes. Nobody invests just for the sake of making money. You invest so you can reach your financial goals and spend that money.

That means your investing strategy should be based on those goals and your own personality.

Unfortunately, most investors think investing is about returns. Pick stocks, make money and somehow your portfolio and financial goals will match up in the end.

Sorry, it just doesn’t work that way. Without a roadmap to your financial destination, you’re just going to be wandering aimlessly in and out of stocks for a few decades. You’ll make all the bad investing mistakes and underperform the market with a 4.6% return or worse.

And you’ll never reach your financial goals.

A Rules-Based Investing Strategy to Avoid Investing Mistakes

Your head is probably swimming in investor mistakes right now and it can seem impossible to keep track of them all, let alone consciously keep from committing them.

Fortunately, remembering the specific investing mistakes is much less important than putting in action some investing rules that will help avoid them. In fact, use this rules-based investing strategy and you won’t have to worry about making mistakes with your money.

  • Asset Allocation Rules – Having set percentages of your portfolio that you invest in stocks, bonds, real estate and other assets is a great way to keep from putting too much in stocks. The mix of these assets will change as you get older and need more safety rather than growth.

We’ve covered these age-based investing rules in a previous article. The idea is that you start as a young investor with mostly stocks but still have some protection in bonds and other assets. At this point, stocks might be as much as 60% or 70% of your total wealth. By the time you reach your 60s, you will have shifted to just 30% or so in stocks and much of your portfolio in bonds.

Having asset allocation rules can help avoid the following investing mistakes:

  • Familiarity – asset allocation forces you to invest in different investments rather than just the ones you hear about most.
  • Over-reliance on Stocks – you may still have a large portion of your portfolio in stocks but you’ll also need to look for investments in other assets.
  • Over-reliance on TV advice – Most TV and internet advice is for stocks so you’ll need to break from the ‘entertainment investing’ industry to invest in other assets.
  • Catching a Falling Knife – your rules for how much you have in each asset will help keep any one investment from becoming a large part of your portfolio.

retirement planning and investing by age

  • Rebalancing Rules – These are the rules you use for when your portfolio moves away from your asset allocation targets. Let’s say you start with 50% in stocks, 20% in bonds and 30% in real estate. Since stock returns easily beat bonds during a bull market, you could be left with 65% in stocks, 10% in bonds and 25% in real estate after a few years of stock gains.

Rebalancing is the process where you shift your portfolio back to your targets. Some people prefer to sell assets that have grown and buy the assets that have lagged. That means paying commissions on the sale and the new purchase. I prefer to just shift more of my new money to the assets that have lagged. In the example above, that would mean using all my regular savings to buy more bonds and real estate until they are again 20% and 30% of my portfolio.

You don’t need to rebalance your portfolio every month or even every year. Let’s say your target for stocks is 50% of your wealth. You can wait until stocks are less than 35%, as might happen in a stock crash, or above 65% after years of stock gains to rebalance.

Setting a margin for your rebalancing will mean you won’t have to watch your investments all the time and rack up trading costs for constant rebalancing. You can let your stocks benefit from a strong market rally and not have to worry about rebalancing for a couple of years.

Having rebalancing rules can help avoid the following investing mistakes:

  • Following the Crowd – You’ll let your stocks go only so far before pulling back a little and taking some money off the table.
  • Fear of Missing Out – Setting margins that allow your best performing assets to run for a while before rebalancing means you’ll get to participate gains.
  • Loss Aversion – Rebalancing and asset allocation take the emotion out of portfolio decisions. This can help from selling your winners too early or keeping losers for too long.
  • Confirmation Bias – Your rebalancing rules aren’t based on the news you seek out that changes your mind on how long the bull market will or will not last.
  • Rules for when to sell an investment will help keep you from making those panic decisions when the market crumbles.

These are the most difficult rules to establish because it means really analyzing a stock. For most investors, there’s nothing wrong with just saying never sell a stock and not worrying about setting rules. If no stock or single investment is more than 5% of your portfolio, even a complete loss won’t significantly affect your long-term returns. Simply not selling your stocks keeps from missing out on an eventual recovery.

If you do decide to set rules for when to sell an investment, consider a checklist of sorts. I only sell a stock if it meets at least two or three of the following criteria:

  • The share price has decreased 10% more than the overall market in less than three months.
  • Two or more from the executive leadership, i.e. CEO, CFO, COO have resigned in the last three months.
  • The company has made a questionable acquisition, paying an extremely high price and taking on a large percentage of debt.
  • The company has been accused of dealing unethically or illegally

These criteria are a high bar and only rarely do I sell any investments. In the last five years, I’ve only sold a few stocks. That includes a couple pharmaceutical stocks and a financial technology company. In every instance, the shares kept plummeting and I was glad I sold when I did.

Having selling rules can help avoid the following investing mistakes:

  • Anchoring – Selling rules are based on new information and will force you to take new details into account.
  • Loss aversion – having definite rules for when to sell can help take the stress out of losing money or whether you should sell a stock.
  • Catching a falling knife – Selling rules like those above will help keep from chasing a company that has committed some of the worst business sins.
  • Single investment or asset rules for percentage of your portfolio – You should set a strict limit for how much a single stock or asset can be as a percentage of your portfolio. For assets like stocks and bonds, this will come from your targets but can vary a little before rebalancing.

For individual stocks, there should be a much smaller exemption for your percentage limit. For example, if you set a rule that no stock should be more than 5% of your portfolio then you shouldn’t let a stock grow to more than a few percent above this before selling.

That’s why I start with no more than about 3% of my portfolio in a stock so I can let it run and not have to worry about bumping up against my 5% limit. Even if the rest of my portfolio does nothing, the stock would have to double before it reaches 6% of my total investments and my rule forces me to sell some of the shares.

Having single-stock percentage rules can help avoid the following investing mistakes:

  • Confirmation bias – It won’t matter how much great news you see about a stock, whether it’s real or just your perception, the rules will keep you from putting too much money on it.
  • Familiarity – Rules keep you from going in too heavily on stocks you know, like investing too much in your employer’s stock.
  • Over confidence – Limiting how much you can invest in a single stock helps to keep over-confidence from putting you ‘all-in’ on an investment. You still might get over-confident in your abilities but it won’t cause as much harm.
  • Base your investing strategy on a personal plan and risk tolerance. This isn’t so much a rule but where every investor should start.

Starting your investing with a personal investment plan takes the guesswork out of reaching your financial goals. You’ll no longer feel the need to jump into far-fetched stock recommendations for returns or pray that the market holds on for just a few more years.

Basing your investing on a personal plan gives you an easy roadmap to your financial destination and puts your investing on auto-pilot.

Basing your investing strategy on a personal plan can help avoid the following investing mistakes:

  • Mental Accounting – you’ll invest to meet all your goals and will understand how all your investments fit together.
  • Hindsight Bias – You won’t have to try timing the market or worry about the next stock market crash. Your investing plan has you covered.
  • Self-Attribution – Investing according to long-term goals takes the short-term decisions out of your hands. Picking stocks is an insignificant part of it and not even necessary.

rules based investing checklist

Why follow a rules-based investing strategy? Because many of the investing mistakes listed above are psychological, emotional behaviors. They’re hard-wired into our brains to think a certain way, thinking that can get you in financial trouble without even knowing it.

By setting some investing rules, you don’t have to worry about your brain getting in the way of making money.

Closing Summary and Action Steps

This was a super-long post but could help save you thousands of dollars. Just understanding some of the biggest investing mistakes and why we make them could be enough to snap you out of committing them. Set up your own rules-based investing strategy and you’ll never have to worry about reaching your goals again!

  • Understand each of the investing mistakes and why they happen.
  • Try to think of a time when you committed each mistake. Understanding the decisions and events that led up to the mistake can help keep you from making it again.
  • Whether you are new to investing or need a fresh start, match your strategy with your goals in a personal investment plan.
  • Create a rules-based investing strategy to keep from committing some of the worst investing mistakes.

Without really understanding and keeping an eye out for some of these worst investing mistakes, it’s going to be very difficult to avoid them. Many are deep-psychological traits that help us in other parts of our lives and are just going to affect the way you invest. I’ve found that a rules-based investing strategy keeps me from committing the biggest mistakes without realizing it.

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