Sometimes really smart people make some really dumb decisions. You know the choices I’m talking about, those ones that when you look back years later, you are left asking “What in the world was I thinking?” Whether irrational decisions are caused by emotions, ingrained biases or a number of other reasons, the fact is, they happen.
Decisions about money and investments are not even close to immune. The economist Thomas Sowell is quoted as saying, “It doesn’t matter how smart you are unless you stop and think.” Let’s do just that; stop and think about some stupid things that we see smart people commonly do with their investments.
Concentrating on your company stock
Most companies make it very easy for employees to invest into their company stock by offering it in 401Ks, ESOP plans, or even as part of compensation for highly compensated and executive level employees. From the company perspective, it makes sense. Not only do they find willing buyers of their equity, but it also further ties employee financial success with the success of the company. For employees, even though you may know the company very well, and the company may have good growth prospects, we believe it is not smart to invest a large portion of your assets into your employer’s stock in most cases.
Remember, when you work for a company, you already have a huge investment in the employer’s success. Your salary, bonuses, benefits, and career are all already tied to your company. We believe you do not need to add further stakes by holding a large portion of your portfolio in the company stock. That may create dual risk where both your income and your investments are reliant on the same company for success and could potentially lead to a situation where both your salary and portfolio are in jeopardy if the company performs poorly.
While concentrated positions in a stock can work out, they can also fail. We think it is smarter to balance your company risk by diversifying into investments other than your company stock. I realize that sometimes diversifying is easier said than done as certain stock and options plans have limited ability to make changes. That said, it should be a goal to reduce those positions when you are able to and where it makes sense.
Focus on timing the market instead of time in the market
Most investors are bad at timing the market, really bad. A study by a company called Dalbar found that in the 10 years ending Dec. 31, 2018, the average stock mutual fund investor earned 9.7% annualized vs. 13.1% for the S&P 500 stock index. Similarly, bond investors underperformed bond indexes over the same time frame.
I’m scared to see what updated numbers will look like for 2020 after all this volatility. While there are multiple reasons for this large performance gap, a big cause may relate to poor decisions around when to buy and when to sell. Understandably, money is emotional. Too often, I think, smart people make stupid money decisions based on fear and greed, and end up locking in losses, missing out on rallies, or buying at the tops.
Unless your name is Warren Buffet, Peter Lynch, and few others, I would say you are better off by focusing on the creation of a sound investment strategy, sticking with it over the long run, and avoiding the emotional ups and downs in the short-run.
Invest money you need in short term
With interest rates so low, it’s downright painful to watch money earn practically nothing sitting in a savings account. That said, I believe the funds you expect to use within the next few years should absolutely be in those boring savings accounts. While certain emotions, like greed and FOMO (fear of missing out), may make it seem like a good idea to put short-term money into stocks, I would argue it’s just not a good idea.
When you have saved enough to achieve a short-term goal, you do not need to put that goal at risk by investing the money. The recent Covid-19 sparked volatility shows us exactly why that is; markets can move quickly due to unexpected causes. It is simply stupid to put finances or a near-term goal at risk for the chance to make a few extra bucks. It is also a decision we see smart people make.
Common sense tells us that making good decisions over our life will help us be successful. I believe most will agree that avoiding bad decisions is just as, if not more, important. The common solution between these three mistakes (and others) I wrote about is to just take the time to think through the situation and make your decisions in a business-like analytical way.
If you need some guidance with your investments, or are looking for a second opinion, check out our process to learn more about how we help our clients.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment loss. As with any investment strategy, there is the possibility of profitability as well as loss. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index.