In my twenty-three years of providing advice and guidance in personal financial planning and wealth management, I have learned several commonalities to one’s success and failure. As you can imagine, my experience provided a ringside seat to how people made their decisions about their money. At this point I have seen it all – at least I think I have. I have identified common traits and habits that produce a successful outcome to build and preserve wealth and I have also learned the most common mistakes many investors make and how best to avoid them. In this article, my goal is to impart my observations and provide you with suggestions to help you make even smarter decisions about your money. Since this is simply an article and not a book, we will describe these areas from a ten-thousand-foot view and perhaps come down a layer or two.
Mistake #1 Market Timing
“I know when to buy/sell, I just have this feeling that the market is due for a crash/surge”. I’ve heard this statement thousands of times. I’ve also heard, “You know Michael, when the market settles down that’s when I’ll buy back in.”
In my experience it seems that many investors, both professionals and amateur, truly believe that they can predict when the market will rise or fall, and they will be able to act by making investment decisions based on those predictions at the right time. Why wouldn’t they? Every time you turn on the financial media, there is some pundit making bold predictions that sound ever so convincing.
It is important to recognize that despite our own beliefs research has shown that market timing is extremely difficult, and in my humble opinion, impossible to do consistently. The most important word is “consistently.”
In the history of the stock market there has never been anyone that timed the market consistently. Yes, lightning does strike occasionally and when it does, you will be sure to hear of their investing prowess and you might even believe they have the Midas touch. A perfect example of this is detailed by a famous mutual fund manager Bill Miller of the Legg Mason Value fund. Miller’s fund outperformed the S&P 500 fifteen years in a row from the early 90’s-2006 and then everything came crashing down, destroying the historical performance.
When it comes to timing, generally speaking, most investors sell near the lows when things are bad because they either need money and/or they tend to panic; they also tend to buy near the highs because they are generally flush with cash and they are drawn into the euphoria. This means their actual returns are works than the market due to consistently buying high and selling low (you are supposed to do the opposite, but I digress).
What you should focus on is what you can control, your investment and financial goals and then have a well-diversified portfolio designed to meet those goals and maintain it and consistently contribute and rebalance your portfolio.
Mistake #2 “FOMO” – Fear of Missing Out
Many investors are tempted to invest in the latest hot stock or fund to get rich quickly. I cut my teeth in finance at the tail end of the tech bubble and dot com boom. Many investors were investing in companies that had no earnings and trading at insanely high valuations.
I remember having dinner with my family and my uncle and his friends (all very successful) were boasting how they are investing in whatever tech stock du jour- when I looked into it, these companies they bought had no or little earnings and were trading at insanely high multiples. Eventually when the music stopped, those stocks came crashing down which led to the tech bubble busting. In hindsight it is interesting to recognize that even very smart and successful people can fall victim to FOMO!
This was not exclusive to the tech bubble. You can find historical instances of it all the way back to the tulip bulb craze in 1600, up to the most recent crypto currency bubble. Investor behavior doesn’t change; the only thing that changes over time is technology and fashion.
This FOMO approach is often driven by emotion rather than sound investment principles. I firmly suggest that you focus on asset allocation and diversification as this is the key determinant factor in your portfolio performance and risk profile, try that instead of trying to chase the latest investment fad.
Mistake #3 Not Considering Taxes
Many investors fail to consider the tax implications of their investment decisions. For example, if you invest $100,000 stock and sell for a $20,000 profit within 12 months, your gain will be treated as a “Short-Term capital gain,” taxed as ordinary income rates, negatively impacting your real return.
If the S&P 500 crashed 20, 30 or 40 percent, would you be happy? Of course not. I encourage you to view taxes on your portfolio as a government-imposed bear market. The only difference is when the stock market experiences a bear market (decline of 20 percent or more) if you have patience, historically you will recoup your money and then some every time. In contrast when you cut a check to the IRS, they generally keep it.
Your portfolio needs to be managed in the presence of taxes. At my firm, we work very closely with tax professionals to coordinate and develop a tax-efficient investment strategy to mitigate tax exposure for our clients. Remember it’s not about how much you make in return, it’s about how much you keep.
Mistake #4 Overreacting to Market Volatility
Many investors panic when the market experiences a downturn and sell their investments in a panic. However, this approach can lead to missed opportunities and lower returns. At the time of this writing June 2023, we are just up ~20 percent from the lows hit in October of 2022 after a rather tough bear market that impacted both stocks and bonds, leaving investors with almost no place to hide.
In my work with people, it seems the primary fear is the market may never come back or just take too long to come back. It is imperative that you stay disciplined and maintain a long-term investment strategy, especially during periods of market volatility. It’s important to remember corrections and bear markets occur often and even the worst ones are temporary. An analogy I like is to view bear markets as the likes of a hurricane. Hurricanes can be destructive and quite scary; however, they are all temporary. Eventually the storm blows out to sea and the sun shines again.
The stated value of your portfolio shouldn’t be your focus. Whether your portfolio goes up or down, it’s a temporary illusion of wealth either created or destroyed, because generally speaking the real value of money goes down due to inflation.
The sole purpose of investing is to have money as a stronghold of wealth that you can convert into buying power in the future. Your portfolio needs to factor in long-term growth above and beyond inflation.
Mistake #5 Failing to Rebalance
The key deciding factor of your portfolio performance is determined from your asset allocation. Over time, however, your investments can become unbalanced due to market fluctuations. For example, a stock that was once a small part of your portfolio may grow to become a larger part due to market gains.
I suggest that you are set up to have your portfolio dynamically rebalanced to ensure the integrity of your asset allocation is always aligned with your financial plan target allocation. This will reduce exposure to areas growing too fast, preventing high levels of concentration in a particular asset class or sector. Dynamic rebalancing uses profits to reallocate those funds to other asset classes and/or sectors that are more attractively priced. This capitalizes on the zigging and zagging of the value of the investments, helping to reduce your portfolio’s cost basis and increases the profit margin.
Mistake #6 Working with the Wrong Advisor
When it comes to managing your wealth, choosing the right financial advisor is paramount, yet many wealthy families and individuals find themselves working with the wrong advisor and many times do not even realize it, leading to planning gaps, red flags, missed opportunities, higher fees, and suboptimal results.
First and foremost, a wrong advisor may lack the necessary credentials or experience to provide the comprehensive guidance required to navigate the complex world of personal finance. Financial advisors as a bare minimum should hold certifications such as the CERTIFIED FINANCIAL PLANNER™(CFP®) or Chartered Financial Analyst™ (CFA®) designations, which demonstrate a commitment to education, ethics, and professional standards. If your advisor does not possess these credentials, it may be time to reconsider your relationship.
Another red flag is the specialization. If you are a business owner and the advisor specializes in corporate executive stock options or helping millennials pay off debt and start a savings plan, most likely you are with the wrong advisor.
Next is a misalignment of interests. A wrong advisor may prioritize their own financial gain over your long-term financial success. This can manifest itself in the form of high fees, hidden commissions, or a focus on financial products that provide the advisor with kickbacks rather than those that best serve your needs. To avoid this, seek advisors who are held to a fiduciary standard, ensuring that they always act in your best interest.
Communication is key in any relationship, and your partnership with your financial advisor should be no exception. A wrong advisor may be difficult to reach or slow to respond to your concerns. An advisor who is not proactive in communicating updates, changes, and recommendations may not have your best interests at heart. Your advisor should be available to answer questions, provide you guidance, and work collaboratively with you and a network of professional advisors to help in your pursuit of your financial goals.
Additionally, a wrong advisor may lack a comprehensive approach to wealth management. Comprehensive wealth management involves more than just investment management – it should encompass tax planning, retirement planning, risk management, estate planning and if you are a business owner, they should have exit planning credentials. A good rule of thumb is If your advisor is solely focused on investment performance, you may be working with the wrong advisor leading to missing out on valuable opportunities potentially helping to optimize your financial situation.
Lastly, be wary of advisors who do not tailor their advice to your specific circumstances. Cookie-cutter solutions are unlikely to yield the best results. It’s important to remember your situation is unique and a bespoke financial plan is paramount. A good advisor must take the time to truly understand your goals, risk tolerance, and financial situation before making any recommendations.
If you suspect you are working with the wrong advisor, don’t be afraid to take action. Reach out to your network, consult your current professional advisors and interview multiple candidates to find the right fit for your needs. Remember, your financial future is at stake, and finding the right advisor can make all the difference in achieving your financial goals.
In understanding the most common mistakes, you are better positioned to avoid these mistakes and maintain a disciplined, long-term investment strategy, which can increase your chances of achieving their financial goals.