SPECIAL FROM Next Avenue
When it comes to investing, you’re doing it wrong. That’s the frank message in The 5 Mistakes Every Investor Makes and How to Avoid Them, the new book by noted financial adviser Peter Mallouk.
I spoke with Mallouk to find out where we’re going astray and, more importantly, how we can address the errors of our ways. “You just need to make one big mistake to wipe yourself out for good,” Mallouk told me.
If you think that’s crazy talk, let me convince you otherwise by presenting Mallouk’s credentials. He’s a certified financial planner and lawyer with an MBA to boot and his firm, Creative Planning (based in Leawood, Kansas), manages roughly $12 billion for 8,000 well-heeled clients. Last year, Barron's named him the No. 1 independent financial adviser in America.
Now that I’ve got your attention, here’s what Mallouk had to say about the mistakes older investors make:
Next Avenue: Let’s take these mistakes in order. Number one: Market timing. What is that and why is it a mistake?
Peter Mallouk: Market timing is the idea that there are times to be in the market and times to be out of it. It doesn’t work. When people get nervous, they pull money out and when the market is stable, they put money in. And some financial advisers play into that fear and greed mentality. When the market is unstable, they say they have strategies to help you.
But no data shows that market timing can be done repeatedly and successfully by anybody. It does more harm than good. If you try to time the market, you’ll get a much lower rate of return.
So when should you sell your stocks?
You should always have a timeline tied to your investment. If you’ll need the money in a year, you shouldn’t buy any stock, no matter how good it is. Short-term needs can’t be met by buying Google or Apple or Nike. You’d be better off buying short- or intermediate-term bonds.
If you’ll be investing for 10 years, you should be in equities. For 20 years, you should be in more aggressive, small-company stocks.
But what if the market goes down during that time, as it probably will?
If the market goes down by 10 percent or less, you should absolutely ignore what’s happening over the short run.
The second mistake, you say, is active trading. Tell me why.
A lot of people say: ‘I’m not timing the market,’ but they’re trading stocks all day long. Studies have shown that what hurts your performance over time is friction — taxes, fees and trading costs. The more you trade, the more you incur these and so you start to have forces of nature working against you. Then you increase the odds that you’ll underperform the market.
But investors should periodically rebalance their portfolios to ensure they have the mix of stocks and bonds they planned, right?
Yes. That’s about controlling risk, not market timing.
How often do you recommend rebalancing?
We don’t follow a calendar on this at our firm, but if I was a guy on my own I’d say rebalance one to four times a year.
You say the next mistake older investors make is misunderstanding performance and financial information. What do you mean?
A lot of people get a piece of information from the headlines or because the Dow goes down and they say, based on that, I should place trades. That doesn’t play out well.
People get freaked out when the market hits an all-time high. But that happens in one of every 19 trading days.
Sometimes, they see that a mutual fund is up 20 percent and they decide that the manager must be a genius so they should invest in that fund. But what really happened is that the asset class the fund buys went up and the manager just happened to be in it.
You also say investors make a big mistake by letting themselves get in the way.
Human nature is geared in a way that’s not helpful from an investment perspective.
Letting yourself get in the way is a behavioral mistake that many people make. They might own Facebook stock and then look for any information that supports why they should keep it or why it will go up. This is called ‘confirmation bias’ and we’re all susceptible to it. You need to think critically about what could go wrong.
Another example of this is overconfidence. You think if you had one success investing, you should jump in big the next time. That leads to underperformance over time.
So how do you keep overconfidence in check?
Look at all your investments on their own. After every success, you need to stop and go through the same due diligence for the next investment. Men tend to underperform women as investors because they hop into investments too quickly and trade more often.
And finally, you say the fifth big mistake investors make is working with the wrong financial adviser. Why?
The biggest problem here is having an adviser who’s really a salesperson in disguise and works with a sister company to sell its own mutual funds.
You need to be sure that you have an independent adviser. When the two of you work together, you’ll have fewer accidents than if you invested on your own. It helps keep your overconfidence in check.