Why do investors lose money? There are lots of reasons. One reason investors who do not seek advice lose money is because they make bad investment decisions. Many of the examples listed below sound like common sense to an experienced financial advisor but go unnoticed by the novice investor. Telling clients about mistakes to avoid is another way advisors add value.
Bad Investment Decisions To Avoid
If you are an experienced advisor reading this article, many of these mistakes or bad decisions will sound obvious. They sometimes never occur to the average investor. Telling them about them can create “aha” moments, help them avoid making bad decisions and appreciate the value of professional advice.
- Buying something you do not understand. People often buy something because their friend bought it. One of my contacts in Asia explained some investors say, “I’ll buy what he is buying.” If you do not understand what needs to happen in the future, you will not know if the company is on the right path. A good advisor explains what needs to happen for a recommendation to work out. They also ask the right questions when a client wants to take an action completely out of character.
- Holding your losers for too long. We all know not all investments work out. The stock zigged when it should have zagged. It is human nature not to want to admit you have made a mistake. Investors hold on for too long, digging themselves into a hole. A stock that declines by 33% needs to rise 50% from that point to bring the client back to even. A good advisor tries to get the client to own several stocks. The advisor keeps an eye on earnings and news. If the stock is sound and the research is favorable, they suggest buying on dips. If not, they look at selling before it declines too far.
- Ignoring asset allocation. Most firms have asset allocation recommendations aligned with investment goals and risk tolerance levels. Letting the equity portion of the allocation grow (even through appreciation) can move the client from one risk category to another. A good advisor periodically reviews asset allocation with the client. Rebalancing is often putting buy low and sell high into practice.
- Owning a concentrated position. This can easily happen when the client has a lot of their company’s stock in their retirement plan at the firm. They might have a favorite firm they have owned forever. This can skew their returns because a larger part of their performance is dependent on what the returns delivered by one stock. If something goes badly wrong with that stock, it can punch a big hole through their portfolio. A good advisor alerts the client to this risk. They also explain strategies they can implement to hedge the risk.
- Think owning five stocks in the same industry counts as diversification. Some clients get the diversification message, but it does not sink in. They avoid the concentrated position problem, yet own several stocks doing the exact same thing in the exact same industry. If a person owned six stocks and five were auto companies or software stocks, would an experienced advisor consider them diversified?
- Losing interest in your stock portfolio. People have short attention spans. You have heard stories of people who buy exercise equipment and stop using it after a few months. You binge-watch a series on cable and suddenly lose interest. It can work the same way with investing. A good advisor schedules periodic reviews with clients, focusing their attention even if they have lost interest.
- Giving up on dollar cost averaging. Your client agrees to add to their retirement assets every month. Your retirement projections are based on assets gradually getting added regularly. The stock market heads down for an extended period. Your client stops sending money. A good advisor reminds them about their retirement goals. They talk about the cyclical behavior of the market. They talk about bringing down the average cost basis. They try to get them back on track.
- Trading on inside information. This is a big one. It might manifest itself when your client does something totally out of character. They “know a guy who knows a guy.” They think they got a “hot tip.” If the advisor can draw them out, they might realize it is inside information. A good advisor reminds them this is illegal, and people get caught. They might not get the first call, but their friend, now “cooperating with the authorities” will not keep their name secret.
- Buying risky investments as you reach for yield. We’ve all heard the term “junk bonds.” People occasionally hear about CDs you can buy from offshore banks, neglecting to realize they are not covered by FDIC insurance. They might assume sovereign debt comes with no risk, but the risk is based on that specific country’s ability to repay its loans. Some have defaulted. A good advisor does not offer this as an investment option. They do their best to change the client’s mind if they bring it up.
- Making long-term investments with money you will need in the short term. We have all heard the expression: “This is a bad time to sell.” We also know investing should be approached with a long-term time horizon. Some money is needed very soon. The client might have a tax bill coming up, for example. They should not choose an investment intended for holding long term when you know you will need to sell soon.
- Being too exposed on margin. Using leverage seems to make sense when the market is going up. It is incredibly dangerous when the stock market declines. A good advisor encourages the client to pay down the margin debit before the market gets volatile.
- Thinking buying lottery tickets counts as an investment. This might seem obvious, but a law firm quotes a section from a statute concerning the Oregon state lottery: “Lottery games are based on chance, should be played for entertainment only and should not be played for investment purposes.” (1) A good advisor reminds clients once the drawing is over and the client has not won, the money they spent on lottery tickets is gone forever.
Even experienced investors make mistakes. A good advisor can make them aware of mistakes and, hopefully, stop them before the damage is done. Advice has value.
Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book Captivating the Wealthy Investor is available on Amazon.