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Avoiding Big Investment Mistakes

To create a portfolio, you have to make many decisions.

You can use low-cost ETFs, or you can use low-cost index funds. Or you could use low-cost actively managed funds like Vanguard’s Wellington Fund or Wellesley Income Fund.

You can use a moderate allocation that stays fixed over time (say, 60% stocks, 40%  bonds), or you could slowly shift your allocation to become more conservative over time.

You can use a “fund of funds” that is a diversified portfolio all on its own (e.g. Vanguard’s LifeStrategy funds), or you can save some money by taking a do-it-yourself approach with individual funds.

You can use a Treasury fund for your bond allocation, or you can use a Total Bond Market fund. Or you could construct a bond ladder from individual TIPS.

You can overweight small-cap/value stocks, or you can stick with a “total stock market” approach.

And the list goes on from there.

I think it’s worth discussing these topics, because you do have to make choice about each of them in order to create and implement an investment plan.

But I sometimes worry that I encourage you (readers) to get caught up in minutiae here on the blog. The reality is that either answer to any of the above decisions (as well as many more that I didn’t mention) is likely to work out just fine. There are an infinite number of reasonable ways to invest.

The Trick is to Avoid the Big Mistakes

From what I’ve seen, most investors’ success (or lack thereof) is determined primarily by whether or not they’re able to avoid the big investing mistakes — things like:

  • Holding a large portion of your total net worth in any one stock (especially your employer’s stock!),
  • Bailing out of the market after big crashes,
  • Getting involved with daily trading of individual stocks, foreign currencies, commodities, etc.,
  • Paying a sizable commission every time you invest, only to invest in funds that have high ongoing costs as well,
  • Listening to certain personal finance “experts” on the radio when they say you can safely withdraw 8% from your portfolio every year throughout retirement, or
  • Not getting started investing until late in your career.

If you get all the big stuff right, you can get many of the small things wrong and still do just fine. Conversely, one big mistake can easily outweigh any incremental gain from having a precisely-tuned asset allocation or shaving a tenth of a percent off your average investment expenses.

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  1. There is one large mistake I did not see on the list. I know I made it. That would be choosing the wrong CFP. I was very busy with family and work to really get into the details with my retirement funds. Right or wrong that was my decision and my decision only. I weathered the .dom crash and the real estate bust but the costs were tremendous. Good bye old CFP and welcome to a very conservative CFP to protect what I have left. I won’t go into details because they don’t really matter now. But if you are within 10 years of retirement evaluate your CFP’s strategy carefully and manage your risk. I hope no one ever looses as much as I have!

    Another point. Don’t EVER use a friend for your financial planning even if he has his own reputable firm.

  2. On “avoiding big mistakes,” from a review of Daniel Kahneman’s “Thinking, Fast and Slow”:

    “Consider the story of Harry Markowitz, a Nobel Prize-winning economist who largely invented the field of investment-portfolio theory. By relying on a set of complicated equations, Markowitz was able to calculate the optimal mix of financial assets. (Due to loss-aversion, most investors hold too many low-risk bonds, but Markowitz’s work helped minimize the effect of the bias by mathematizing the decision.) Markowitz, however, was incapable of using his own research, at least when setting up his personal retirement fund. ‘I should have computed the historical co-variances of the asset classes and drawn an efficient frontier,’ Markowitz later confessed. ‘Instead, I visualized my grief if the stock market … went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities.’”

  3. Floyd: I agree about not using an advisor with whom you’re close in a non-professional way (friend, family, etc.). If the professional relationship goes poorly, you want to be able to get your money the heck out of there without having second thoughts about damaging the friendship.

    Larry: That quote has been near and dear to me since the fist time I read it. (Perhaps in a book by Bogle? I’m not sure.) The fact that somebody with such knowledge and analytical skills can be perfectly happy with the simplest of portfolios for his own personal use is really saying something.

  4. Larry & Mike:

    Everyone likes a good story, but what lesson should we take away from the father of MPT not using MPT for his own investments? That he understood his own emotional loss aversion and preferred to be happy rather than to be right? Or did he reason that the historic correlations in his models were limited in predictive power and would not be robust in times of economic crisis, so he chose a simpler but more robust personal investment strategy?

    A quick web search shows that as of 2010, Nobel prize winner Harry “Markowitz, by the way, says he has about 60% of his own portfolio invested in exchange-traded stock funds more heavily weighted toward small companies and emerging markets. The rest is invested in short-term and intermediate-term bonds—not bond funds, which he believes invest in ‘too much crap.'”

  5. One more I would add is not giving investing the time it deserves. You spend 40+ hours a week earning a living, but how much time do most people spend learning to invest? Considering investing is how you can earn and build wealth to live on in your golden years, an hour or two a week learning how to invest wisely and efficiently doesn’t seem like much considering the potential reward you can earn for the effort.

  6. The common mistakes I see with people investing on stocks are portfolio concentrated on big names only and less time investment. I believe that when investing on stocks, one should have a diversified portfolio and spend time building the wealth. We cannot just sit and wait until it is ready to harvest.

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