Starting with Nassim Taleb’s sardonic story about forecasting. As the tale goes, a trader listened to the firm’s chief economist provide a forecast about the markets and then lost bundle acting on it, getting him fired. The trader angrily asked his boss why he was fired rather than the economist, as the economist’s poor forecast led to the poor trade. The boss replied, “You idiot, I’m not firing you for losing money. I’m firing you for listening to the economist.”
Here is a different sort of “top ten” list of interrelated investment insights and recommendations – mistakes that are both common and deadly – for us to try to correct for 2015 and beyond :-
- We don’t prioritize properly in financial planning: Your savings rate is far more important than your rate of return in determining how bright your future is likely to be. However, we are far more likely to obsess over squeaking out a bit more performance out of our investments rather than thinking about ways to save more.
- We complicate things unnecessarily: Einstein wisely advised that we keep things as simple as possible, but no simpler. Overly complicated systems, from financial derivatives to tax systems, are difficult to comprehend, easy to exploit, and possibly dangerous. Simple rules, in contrast, can make us smart and create a safer world.
- We don’t invest: The stock market is scary. Investing there requires that we be prepared for major losses as serious draw-downs are part of the package. People might be less scared of volatility if they knew how common it was. Some people react to the reality that markets go down sometimes and sometimes by a lot by avoiding stocks altogether. But doing so is a huge mistake.
- We don’t stay invested: Out of our general fear, even if and when we invest, we often don’t stay invested.
- We don’t diversify : Don’t put all of your eggs in one basket. A single holding has huge potential for gains if the right instrument is selected, but even huger risks (because investing “home runs” are so hard to come by). In general, the greater a portfolio’s diversification, the lower its risk. Lower risk is a good thing, but only if the portfolio’s potential return is healthy enough to meet the client’s needs.
- We value investment choices over asset allocation:A portfolio’s results are largely dictated by overall market performance during any given time period. In other words, the more risk-averse strategies will generate better returns in a difficult market by protecting the downside and the reverse will also tend to be true, that managers with higher risk tolerances will be more likely to succeed during periods of strong market returns. The conventional method of mitigating this dilemma is to “risk adjust” the results, comparing nominal returns with volatility, but this approach is uncertain at best in that volatility and risk are hardly the same thing.
- We try to time the market: The idea that an in investor ought to be aware and nimble enough to avoid market downturns or simply to find and move into better investments is remarkably appealing. Just show me any who have done it repeatedly.
- We fail to consider costs: The leading factor in the success or failure of any investment is fees. In fact, the relationship between fees and performance is an inverse one. Every investor needs to count costs.
- We fail to consider incentives: Multiple studies all establish what we should already know. A manager with a significant ownership stake in his fund is much more likely to do well than one who doesn’t. Make sure to look for “skin in the game” from every money manager you use.
- We try to go it alone: We all work better with help, advice, support, correction, criticism and accountability. Make sure you aren’t trying to go it alone in the investment world.
Let’s start by systematically eliminating our most obvious mistakes.