The 8 Great Investment Mistakes To Avoid

Euphoria

It is the complete loss of an adult sense of danger. Your only concern is that somebody somewhere owns stocks that are going up more than yours.

Panic

There is a consistent relationship between the height of the "mob's" euphoria at the top of a big bull market and the depth of their panic-induced capitulation at the bottom of the concomitant bear market. Panic is the pure essence of a loss of faith in the future.

Leverage

This is when you borrow money, maybe against your home equity or on margin from a broker, to purchase an investment. In practice, most people borrow at the wrong times and on the wrong terms, in order to buy the wrong things at the wrong times for all the wrong reasons. The loan reduces the investment gain (if there is one) and increases the amount of the investment loss (if there is one).

Speculating When You Think You Are Investing

All short-term trading is speculation, in that fundamental values do not change quickly. An investor is always interested in long-term improvements in earnings, cash flows and dividends. A trader is interested in quick changes in price and is therefore always a speculator.

Similarly, all options and all futures contracts are speculation rather than investments because their ending value after expiration is zero.

Overdiversification

Example: a person invests once a year and every year they put the new money into the top-performing equity fund on Forbes's Honour Roll. Twelve years later, this person owns a hodgepodge of 12 mutual funds, because-like Miss Universe - nobody wins twice. This will result in an expensive index fund with gaps, redundancies, and fee inefficiencies.

Under Diversification

The fatal narrowing of a portfolio down to essentially one idea. Holding the preponderance of your equity "portfolio" in one stock is not investing. It is Russian roulette. Every day when the market opens, you point that gun at your head and pull the trigger in what economists' call "creative destruction".

Investing For Current Yield Rather Than Total Return

This is a mistake made by many retirees.

Investments which have the highest current yield (such as interest or dividends) have the lowest total return, while investments with lower current yield (such as interest or dividends) must-in an efficient market-compensate by offering the higher long-term return. The only rational test of an investor's long-term income-producing potential is its long-term total return.

Letting Your Cost Basis Dictate Your Investment Decisions

Your cost in an investment has nothing to do with its objective value today. Your investments do not know what you paid for them and would not perform any differently if they did.

One way this will show up is the refusal to migrate back toward proper diversification because one very successful investment would, were it sold, generate capital gains taxation. This will then lead to under diversification since that successful investment becomes a greater percentage of the overall portfolio.

The other way this will show up is when an investor decides they cannot take the loss on an unsuccessful investment even though the fundamental have completely changed: indeed, no objectively verifiable fact matters.