A Look at the Reasoning behind Common Investor Mistakes
Most of us have made an investment blunder (or two!) of one type or another. Although we can’t avoid all investment mistakes, we can learn from those we’ve made and benefit from what we’ve learned. And what better time than the new year to do so.
By far, one of the most common and costly mistakes involves holding on to a losing stock or investment. There’s a very human tendency to believe in the big comeback: a great return after a devastating loss. That sentiment is how many investors look at a losing stock. Psychologically, it hurts to recognize when we’ve lost some of the money we’ve invested. But there’s a cost to hoping against hope that a loser will become a winner. We’d be better off selling the losing stock and putting the proceeds into an alternative investment that appears likely to have better returns.
Although a lot of investors don’t want to realize a paper loss, some do the exact opposite. We avoid a realized gain because we want to avoid its tax consequences. Our disdain for paying taxes can lead to our holding on to investments for too long. By that time, the drop in value could be greater than what we would have paid in taxes on the gain. Also, letting taxes drive our investment decisions means our portfolios can become distorted, weighted too heavily in the stocks we don’t want to sell due to tax concerns.
Other times, investors simply maintain a false sense of diversification. For example, those of us who hold several different mutual funds may consider ourselves fully diversified. However, if those mutual funds have identical investment objectives—say, three different mutual funds that all focus on small-cap growth companies—then they’re not providing the intended diversification. In that case, we could gain diversity by converting one of those funds to a large-cap fund with a focus on value stocks and the other to a mid-cap fund that seeks both growth and value stocks.
Everyone wants a piece of a shining star, and many investors catch a news bite or see a company’s stock highlighted in the media and figure it’s the next hot stock. As we hear more and more about it from various sources, we may feel confident enough to buy. Chances are, by then, it’s too late. A stock that’s a media darling most likely has already had a lot of expectations built into its price.
Another big mistake investors make is buying a company stock after a sudden price drop. To many of us, a cheap price equals a good deal. We don’t look beyond the market price of a stock to determine its relative value. And chances are that a recent, precipitous plunge is likely the result of a significant change of circumstance in the company.
In life, some are always looking for the next best thing, the greener pasture. For the investor in us, the tendency to look for and trade into the next best investment can lead to excessive trading. The churn effect on investing can represent another costly investment mistake and can significantly impact any gains on those investments.
Although we can’t cover all investment mistakes here, these are some of the most common and costly and why we continue to make them. As the saying goes, “Those who do not learn from their mistakes are doomed to repeat them.” Often times, knowing where we went wrong keeps us from going wrong again.
This article is provided by RBC Wealth Management on behalf of Gary Kiemele, a Financial Advisor at RBC Wealth Management, and may not be exclusive to this publication. The information included in this article is not intended to be used as the primary basis for making investment decisions. RBC Wealth Management does not endorse this organization or publication. Consult your investment professional for additional information and guidance.
RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.