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The Biggest Investment Error You're Making (And How to Fix It)

The Biggest Investment Error You're Making (And How to Fix It)

By    |   Thursday, 26 April 2018 03:38 PM

It’s amazing how easy it would be to screw up my life. Sure, I’ve been investing for decades, honing my skills as a financial writer, and otherwise adding value to society by sharing the things I’ve learned.

But one tirade that goes viral on social media could change all that. A few investment mistakes, and I could see a huge drop in my net worth—enough to throw off longer-term plans.

That’s true in any endeavor. It’s easier to destroy than create.

We all make mistakes. There’s nothing wrong with that. In and of itself, that’s simply a part of our life.

But how we make mistakes, the size of our mistakes, and how we learn from them matter.

Most investors fall into a variety of traps. It’s just the way our brains are wired. We’ve only had financial markets for a few hundred years, and it’s continually increasing in complexity. Meanwhile, our minds are still wired from our days as cavemen. Things like “fight or flight” responses can override our ability to engage in rational thought and lead to mistakes.

No matter how astute you are, it’s going to happen. I’m no exception, but I’ve tried to make as many mistakes as possible when the stakes were far smaller than they would be for me now.

So what’s the biggest mistake investors make? Getting caught up in an investment for emotional reasons.

Maybe you’re overconfident that a company’s new product will be hot and not a dud. Maybe you’re valuing a company on some esoteric value like its land holdings and not thinking about how the market is treating it. It doesn’t matter. Once you’ve anchored your mind to the value of a company for the wrong reasons, it’s tough to get back on track and look at things objectively.

Once you’ve started making emotional decisions, it’s easy to rationalize and ignore the facts.

Consider Warren Buffett’s investment in IBM (IBM). Buffett invested in the struggling server company back in 2011. Buffett knew that the company wasn’t the leading firm in its industry anymore, and that it would likely be a lagger. Yet he was so caught up in the idea that a depressed share price plus a large buyback would compensate for the struggle over time that he didn’t consider a margin of error.

Some companies can struggle indefinitely. Most have to innovate, or else they get sold off, spun off, or go bankrupt. If a company’s not leading its industry, it’s got problems. Buffett would have done better in the company secretly leading the server space right now, Amazon (AMZN).

Recognizing and understanding the problem is the first step. The second step is more difficult, but critical: fixing it.

It’s tough to keep emotions out of investing. It’s probably impossible at times. During extreme market moves, when your net worth is fluctuating rapidly by the second, it’s hard to shut out excessively positive or negative thoughts.

But there are ways to keep emotions in check.

First, is to use and follow a plan. That plan may include targeting a net worth, and checking that monthly, but not weekly or daily. A better plan might be to target a certain level in dividend income each year (which in turn helps keep your tax rate as low as possible on your investments). Every person has different needs, and different ways of thinking about risk in the stock market, so there’s no one-size-fits-all strategy here.

Second, look for ways to reduce risk. Instead of buying 1,000 shares of a high-flying tech stock that may rally 20 percent before crashing 10 percent, buy 10 call options instead. It takes less capital, but can still capture most of the gains provided it takes place quickly.

That gives your portfolio a growth kicker without using an excessive amount of your wealth to begin with. With today’s choppy markets, a big down day for a tech company is an opportunity to buy long dated call options and wait for the sentiment to turn around for a quick profit.

Third, look to increase your holdings in great companies in stodgy industries when they’re down. That’s a way to target a new investment with higher dividend income in mind. Right now, AT&T (T) is closing in on a 6 percent yield. At that price, the market has low expectations for the company. But to reach the stock market’s long-term average of 8 percent per year, it only has to rally 2 percent once the dividend is factored in. While the telecom company is facing a few issues right now, those concerns will fade in time.

Finally, reducing emotion means making plans when things are going well. If you have a position that’s had a huge rally, it may be better to take profits rather than wait for a market panic when half your gain has just disappeared. If you’re not ready to sell, or expect the stock to simply trade sideways for a while following a long rally, a strategy like selling a covered call option can provide you with more income—and the chance to sell out at a price you’ve decided in advance where you’re comfortable taking profits.

At the end of the day, a few rational decisions will make your investment career. A few emotional decisions will likely ruin it—or keep it from ever being truly successful. Think about the positions you own, and why you own it. Think about how you’d explain that investment to a five-year old. If you can’t come up with a rational explanation, it’s time to think about reducing or eliminating that portfolio position.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

© 2021 Newsmax Finance. All rights reserved.

No matter how astute you are, it’s going to happen. I’m no exception, but I’ve tried to make as many mistakes as possible when the stakes were far smaller than they would be for me now.
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Thursday, 26 April 2018 03:38 PM
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