Don't Make These Investment Mistakes!
First, a story: On their honeymoon in Las Vegas, two newlyweds lose their $1,000 gambling allowance in three days. That night in bed, the groom notices on the bedstand a five-dollar chip that he had saved as a souvenir. The number seventeen is on the chip's face. Taking this as an omen, the groom puts on his green bathrobe and rushes down to the casino.
At the roulette tables, the groom places the five dollars on the number seventeen. Sure enough, he wins $175 on the roll. He lets the winnings ride, wins again, this time collecting $6,126. He keeps winning, and letting the winnings ride, until he's won $7.5 million. He lets the $7.5 million ride - and the ball hits 18 instead of 17. The groom, completely broke, goes back to the hotel room. "How'd it go?" asks the bride. "Not bad," he replies. "I lost five dollars."
Investing in Any Market
The title of Rational Investing in Irrational Times is a bit misleading: This is not a book about how to invest rationally in today's unpredictable markets; it is a book about how to invest rationally in any market. In fact, a more accurate title would have been Why Smart People Make Dumb Investment Decisions.
Author Larry Swedroe, a principle in the investment advisory firm of Buckingham Asset Management, offers a list of 52 costly mistakes - presented in the form of a question - that people make when investing their money. The story of the man in the green bathrobe, for example, illustrates mistake number 13, "Do You Believe You Are Playing with the House's Money?"
The mistake in this case involves what some call "mental accounting," That is, the mistake of valuing some dollars less than others, and thus wasting them. In the groom's mind, the $7.5 million he wagered was the house's money, not his. Since he was not risking $7.5 million of his own money, he could afford to lose it. The truth, of course, is that the groom did not lose $5; he lost $7.5 million.
Swedroe illustrates this case with the real example of a friend who had the good fortune of buying Cisco stock when it cost $5 per share. Eventually, the stock reached $80 per share. Although the friend refused to buy more Cisco stock - thus acknowledging that the stock might be overvalued - he would not sell it either. Instead, the friend held onto the shares because he believed he had nothing to lose: After all, he had bought the shares at five. Of course, the friend did have much to lose - and lose much he did as Cisco's shares plunged within three months from $80 to $13.
Categories of Mistakes
Swedroe organizes his mistakes into four categories:
- Understanding and Controlling Human Behavior Is an Important Determinant of Investment Performance.
- Ignorance Is Bliss.
- Mistakes Made When Planning an Investment Strategy.
- Mistakes Made When Developing a Portfolio.
Mental accounting - believing that you are playing with the house's money - is a human behavior mistake. So is letting ego dominate the decision-making process (mistake 5); allowing yourself to be influenced by a herd mentality (mistake 6); and projecting recent trends indefinitely into the future (mistake 2).
In the "Ignorance Is Bliss" category are such mistakes as relying on misleading information (mistake 16) and failing to consider the costs of an investment strategy (mistake 18).
Do you fail to tax manage your portfolio throughout the year? Do you rely on market gurus? Do you work with commissioned advisors? These are some of the mistakes (numbers 35, 39, and 41 respectively) that people make when planning an investment strategy.
Finally, mistakes made when developing a portfolio include having too many eggs in one basket (mistake 44) and underestimating the number of stocks needed to build a diversified portfolio (mistake 45).
Why Soundview Likes This Book
Whether you're just starting to explore the stock market, have questions about your past investment choices or want to take advantage of changing circumstances, this highly valuable, well-organized guide will put you on alert to the many mistakes you might be on the verge of making. Keep this one on your shelf.