Minimizing your investment mistakes can be an easy way for you to increase your probability of long-term investment success.
Well today you’re in for a treat because we’ve put together a comprehensive list of the top 50 investment mistakes that either you or your investment advisor may be making with your investment portfolio.
We must warn you - this is a long article.
Some of the investment mistakes mentioned in the article are also covered in a recent episode of the The Anxious Investor podcast.
The list is in no particular order of importance, because all of the investment mistakes are important and should be avoided or minimized as much as possible.
Now let’s get into them.
No investment plan.
Investing without an investment plan is like taking a road trip without your GPS or map. Without a GPS or map it would make reaching your destination challenging if not nearly impossible.
Well, investing has many similarities to planning your next vacation or road trip. Before ever investing a single dollar you need to determine your investment goals and then break those goals down into short-term and long-term goals. Next, you will need to decide how much that you will allocate to stocks and bonds based on the time horizon of your goals.
Of course the shorter-term your goals are the less you should invest in stocks and the longer-term your goals are the more you may wish to place in stocks.
Finally, you need to choose which individual investments that you will purchase to represent the stock and bond portions of your portfolio.
You should seriously consider index funds in your investment selections for all or a large portion portfolio assets. Index fund are low-cost and widely diversified.
Too much invested in the stock of the company where you work.
We have all heard time-and-time again that you should not have all your money invested in one stock. Regardless of this timeless advice, you could still be investing almost all of life savings in your employers stock. Just take a minute to think about this.
Do you want all your hard work and life savings tied to one company? Well, when you invest a large portion of your savings in the stock of the company where you work you are doing just that.
You ultimately have all your financial goals tied to the performance your employer and its stock price. You are relying on your employer to pay you a salary and then in turn you turnaround and invest a portion of your salary in your employers stock and hope that the stock performs well.
If you invest in the stock of the company where you work please take a few minutes and see what percentages of your total investment assets are tied to that one stock.
Under almost any circumstances you should never have more than 10% of your total investments in your employers company stock or any single company stock.
This includes not just direct long stock investment positions, but also stock options that your employer may offer you. In other words, determine what you total exposure is to the company where you work.
Not rebalancing your investment portfolio.
Rebalancing your investment portfolio is a critical portfolio maintenance practice that helps you manage the risk in your portfolio.
There are unless ways you can rebalance your portfolio, but in the end, the only way that really matters is actually selecting an approach and doing it.
Don’t get bogged down with analysis paralysis in trying to find the optimal rebalancing method.
To make rebalancing simple and to ensure its gets done you may wish to simply use a calendar year rebalancing approach.
Using that approach, once a year, in let’s say January, you should look at your investment portfolio and sell any investments that are greater than the target percentage and purchase any investments that are below the target percentage.
This once-a-year approach keeps things simple and gets the job done to ensure that you are not taking unnecessary risk.
If you never rebalance your investment portfolio then overtime you could end up taking more investment risk than you need in relation to your investment goals.
Not having enough diversification in your investment portfolio.
Diversification is not always about how many individual investments you hold in your portfolio, but rather it’s about what exposure those holdings represent.
You should have target percentages allocated to various asset classes and styles in your portfolio and typically purchase one diversified investment (index funds) to represent each asset class or style.
Take a few minutes to see if you hold investments that properly represent your target asset classes and styles. If not, now is just as good of time as any to make adjustments to your portfolio to bring it inline with your assigned allocations and asset classes.
X Having too much diversification in your investment portfolio.
We just discussed not having enough diversification in your investment portfolio, but you can also have too much diversification in your portfolio.
Purchasing multiple mutual funds for the same asset classes and styles in your portfolio is not going to help manage the risk any better than purchasing one mutual fund (index fund) to represent each asset class and/or style in your portfolio.
The mistake with purchasing multiple mutual funds for each asset class and/or style is it makes managing your portfolio more complex and typically drives up your investment costs and at times can cause you to chase the better performing funds rather than focusing on your investment plan.
Chasing investment performance.
We’re all human and we always want to have the best and perform the best. We don’t want to be average.
But when it comes to investing, one of the most devastating things you can do in managing your portfolio is chasing recent investment performance and then purchasing those investments thinking they will perform the same way in the future.
Above average investment performance is typically a result of market fads or trends and if you’re looking at historically great performance for an investment then usually you are already late to the party.
The only time investment performance is important is when you are comparing an investment to a benchmark to ensure it is properly tracking the market or style you are targeting. Outside of that, historical performance is really a useless data point.
This is completely contrary to what Wall Street pushes inits marketing materials. Instead focus on your investment fees, asset allocation strategy and investment goals and less on chasing performance.
Being average when it comes to investing is a good thing.One last thought...hot performance is almost always associated with more risk.
Remember, risk and return are directly related.
Paying too much in investment costs and fees.
Are you paying too much in investment costs and fees? Well, the short answer is, you could be without even knowing it.
Reviewing your investment costs and fees requires more than knowing what you are paying to your investment advisor or how much you are paying in transaction fees or commission to purchase individual investments.You need to review your total investment costs.
Those costs can include the following: mutual fund and ETF expense ratios, 12-b(1) fund fees, custodian fees, broker-deal transaction fees and/or commission, investment advisor fees and/or commissions (if you use an advisor) and taxes.
This is not an exhaustive list of costs and fees, but rather some of the more common costs and fees that you may be paying to manage your investment portfolio.
Remember, the lower your costs, the more of your investment returns you keep. After all, you are taking the investment risk, so you should be keeping as much of the returns as you can by keeping your total investments costs as low as possible.
You would be surprised how many fees and costs are negotiable, especially when it comes to investment advisor fees. You just have to ask.
Not controlling the things that you can control when managing your investment portfolio.
There are many things that you can control when managing your investments that can set you up for long-term investment success.
However, the one thing you can’t control are the stock and bond markets. But there are things within your control.
You can control what individual investments you buy and sell, which hopefully are index funds.
You can control your fees, costs and taxes to pay as little as possible for each.
Remember, thinking you can control the markets or knowing how the markets will perform is a complete waste of time.
Instead allocate your time to reviewing and controlling the items mentioned that you can influence.
Focusing too much and too little on taxes.
Keeping the amount you pay in taxes on your investments as low as possible will help you keep more of your hard-earned money, but taxes should not be looked at in isolation from other portfolio management functions such as rebalancing.
It’s easy to blindly rebalance your portfolio without any regard for taxes, but that is not reality unless you are working exclusively with tax-deferred retirement accounts.
Any trades in your taxable accounts can drive up your tax bill when you sell portions of your investments at a gain to rebalance your portfolio.
So what should you do about taxes when rebalancing? First, don’t let taxes take priority when managing the overall risk of your investment portfolio when it comes time to rebalance.
But at the same time you don’t want to simply incur any typeof capital gains. Since short-term capital gains are taxed at higher ordinary tax rates, therefore the first investments you will want to sell when rebalancing your portfolio are at long-term capital gains, which are taxed at more favorable capital gain tax rates.
Don’t be afraid to take long-term gains capital gains as needed when rebalancing.
Taking too much risk in your portfolio simply to avoid taxes is not a wise long-term investment strategy.
Putting all of your eggs in one basket.
We have all heard the saying “don’t put all your eggs in one basket,” but unfortunately a lot of us never practice this timeless rule.
You wouldn't believe how many times we see investors holding non-diversified investment portfolios concentrated in a few mutual funds, stocks, bonds or even worse all their money in the company stock where they work.
Diversifying your portfolio is a critical key to investment success and controlling the overall risk in your investment portfolio.
As a rule of thumb you should almost never have more than 5%of your total portfolio invested in any one single investment unless it is a globally diversified index fund holding thousands of stocks or bonds.
Thinking short-term, not long-term.
Investing in stocks is all about thinking long-term. Since no one is able to predict the future direction of the stock markets or when a market might have a correction, it makes for investing in stocks for short-term goals nearly impossible and should be generally avoided.
Therefore, when investing in any stock related investments be sure that your goals are at least ten years away to allow time for your portfolio to recover from any decline the markets in the short-term.
Splitting your investments among multiple investment advisors.
If you have an investment advisor assisting you in managing your investment portfolio hopefully you only have one advisor.
You might think to yourself, since it make sense to diversify your investments in your portfolio in order to control or minimize investment risk then maybe you should diversify investment advisors.
That sounds good in theory, but in practice having multiple investment advisors is often a bad idea. When you have multiple advisors you will often receive very different advice and recommendations.
That may sound reasonable if that is why you hired multiple investment advisors, but you need to remember that most people hire investment advisors for the advice and ongoing portfolio management services they provide so they don’t have to spend too much time managing their own investments.
When you hire multiple investment advisors you have now placed yourself squarely in the middle as the person who will make all the final day-to-day portfolio decisions and communicate and coordinate between the multiple advisors and evaluate which advice you will use.
At that point the logical question is why hire an investment advisor if you have do just as much work coordinating between advisors?
Also, hiring multiple advisors can potentially increase your taxes.
When you have multiple advisors buying and selling some of the same individual securities you may have one advisor doing some tax-loss harvesting and another advisor purchasing the same investment being sold for tax-loss purposes, thereby voiding the tax-loss that could have been used to lower your taxes.
Mixing emotions and investing.
Emotions and investing are like oil and water. They don’t mix. Typically the more emotional you are with your investments the more mistakes you could possibly make in managing your portfolio.
It’s hard not to get emotionally when you see your investments performing very well or the reverse, the market drops 10%-20%.
If you have a written investment plan that clearly details your investment goals and your asset allocation strategy then all you need todo is follow the investment plan. That’s easier said than done.
For that reason the single most important thing you may want to consider is hiring an investment advisor so you won’t make emotional mistakes with your money.
An investment advisor can act as a circuit breaker between your emotions and the markets. It’s easy to say you're not going to be emotional about your money when the markets have gone up, but once things head south it’ soften a very different story.
Don’t get emotional. Emotions have no place when it comes to investing. Follow your investment plan.
Purchasing annuities as investments.
First, let’s get this out of the way. Annuities are not investments, they are insurance contracts. Annuities are regulated by insurance commissioners, not securities regulators.
If you have a valid reason for purchasing an annuity that is fine, but the vast majority of people are sold annuities because of the high sales commissions that are paid to the insurance agents and brokers who sell them.
Some annuities can be confusing because the money you use to purchase the annuity can be invested in sub-accounts using mutual funds. This is often touted by insurance agents and brokers as an attempt to confuse you into thinking annuities are investments.
Purchasing mutual funds in sub-accounts is often more costly than purchasing the same mutual funds directly from the fund company or through a custodian.
For those reasons you should stop and think twice before purchasing any annuities to make sure you really need an annuity.
If you already purchased a high cost annuity all is not lost. You should look at other lower cost annuity options that you can then transfer the annuity premium that you paid on your current annuity into a lower cost annuity using a 1035 Exchange.
Purchasing annuities with your IRA or retirement account assets.
One costly mistake you should avoid is purchasing annuities with your IRA or other retirement account assets.
Often times insurance agents and brokers market and sell annuities products to you under the guise of the advantages of the tax-deferred structure of annuity products.
The big mistake with this approach is that IRA and retirement account assets are already tax-deferred retirement accounts, so you don't need double tax-deferral.
This is simply a gimmick to sell more annuities and you receive zero benefit and then get saddled with the high annuity fees and high commissions paid the the insurance agent or broker who sold you the annuity, as well as the high ongoing annuity costs and fees.
Hiring investment advisors who believe they can hire other advisors who can beat the market.
If you already have or plan to hire an investment advisor who believes in active investment management and they in turn pick other managers that will try to beat the market you should seriously consider running as fast as you can in the opposite direction. This is active management at its worst.
First, it is extremely difficult, if not nearly impossible for any investment advisor to consistently pick the correct active managers/advisors who in turn will try to pick the correct individual investment to will outperform the markets.
Next, even if your investment advisor gets lucky and happens to select a manager/advisor who beat the markets in any given year, the problem is they won’t be able to do it consistently over the long-term and certainly not without added risk in your portfolio.
Finally, active investment management is expensive and you should not be paying high fees and assuming more risk simply so investment advisors can “try” to beat the market.
You don't need to beat the market and certainly you don’t need to take the risk associated with trying to beat the market. Again, being average is just fine.
Not investing the amount you should in your 401(k) plan to reach your full employer match.
This is one of the single biggest mistakes you could be making when contributing to your 401(k) plan.
Unless it would cause you undue financial hardship you should always be contributing the maximum amount to your 401(k) plan that is required to receive the full matching amounts from your employer.
This is “free” money. You’re never going to have a risk free rate of return like free money provides. Think about this for a minute.
As an example, if your annual salary was $50,000 and your employer matched the first 4% of salary dollar-for-dollar the math would look like this: $50,000 x 4% = $2,000 (your contribution) + $2,000 (employer contribution) = $4,000 annual contribution into your 401(k) plan.
Of course you can always contribute more to the plan, up to the annual IRS maximums allowed, but to receive your full match in the prior example you would need to contribute 4% of your income to receive the $2,000 of“free” money from your employer match.
That’s a 100% return on your money even if you never invested it other than held it in cash.
If you invested 2% of your income in the prior example you would only receive $1,000 of employer match money, so if our able you always want to contribute the full amount in order to receive the maximum employer match for the year.
Investing in taxable accounts before maxing out your retirement account contributions.
There are many tax-advantaged investment accounts you can use to save money. Some of the more popular accounts are 401(k) plans, IRA accounts, Roth IRA accounts, and taxable accounts.
You’ll want to take a few minutes and review the types of accounts that you currently have and make sure that you are saving money in the right types of accounts and in the correct order.
You should first invest your savings in your company 401(k)plan (especially if there is an employer match), next a Roth IRA account, next an IRA account (only if you receive a tax deduction for your contribution). All savings after that should go into your after-tax taxable account.
Many people save money in their taxable accounts first and don’t enjoy the tax deferral benefits that tax-deferred retirement accounts provide.
Besides from the disadvantages of market timing associated with frequent trading there are also other disadvantages if you frequently trade in your investment portfolio.
Each time you place a trade there is typically a transaction fee that your custodian or broker-dealer charges you to place the trade. Those fees can begin to add-up over time even if they seem low-cost and reasonable today.
Another disadvantage with frequent trading in taxable accounts is potential realized short-term and long-term capital gains taxes that you will owe on any profits made from your trading.
Investing and trading are two completely different things, but they are often combined under the term “investing” that can cause confusion. Trading is speculation, whereas investing is purchasing securities to be held long-term to reach a goal.
Making investment decisions based on fear and greed.
Making investment decisions based on fear and greed is similar to mistake #13. As we know, fear and greed are both emotions. We already discussed in mistake #13 that emotions and investing are like oil and water and they don't mix.
If you are someone who tends to make investment decisions based on fear or greed then you may be at risk of making an investment decision one day that has a huge adverse impact on your portfolio.
Most people who make emotional decisions out of fear or greed are often best served by hiring an investment advisor who is able to manage your portfolio without emotions. This way your investment advisor can act as a circuit breaker between you and the markets.
Hiring the wrong investment advisor to help you with your investments.
When it comes to investment advice there are many different types of advisors. Keep in mind that we use the term “advisor” loosely here.
The most common types of advisors you may find yourself talking with are investment advisors, brokers and insurance agents.
If you already work with an advisor you should know how your advisor is paid to help you evaluate which type of advisor you are working with or may consider hiring.
Typically investment advisors are regulated by the U.S.Securities and Exchange Commission (SEC) or state securities regulators.Brokers are regulated by FINRA and insurance agents are regulated by state insurance commissioners.
Brokers and insurance agents work on commission and work on a transactional basis, where investment advisors are typically paid on afee-only basis, but they can also receive commissions if they are affiliated with a broker-dealer, so do your homework.
Out of the three types of advisors, an investment advisor is the only advisor you should be looking to hire if you want someone to provide you with advice and work with you in a fiduciary capacity, who puts your best interests ahead of their own.
Any advisor you are working with or plan to work with in the future should be properly registered and have a clean regulatory record. Again, do your homework.
Confusing luck as skill in bull markets.
In a bull market often times you might think you or your investment advisor have a certain level of skill in selecting individual investments because your portfolio has likely been performing well.
But is your portfolio performing as well as it should?Typically in bull markets you can make investments in almost any stocks, mutual funds and ETFs and make money, but you may be taking more risk and making less return than you think.
You should evaluate the holdings in your portfolio against appropriate market benchmarks to determine if your investments have performed close to the actual performance of the market benchmarks.
Take some time and compare your investments to the benchmarks to see if you should have done better. It may be time to make a change in investments even if they are performing well.
Chasing the next hot stock, idea or industry.
Chasing hot stocks or ideas that someone tells you about or that you read on the internet, hear in the news or on TV is a recipe for investment failure.
Granted you may get lucky and get into a hot stock, sector or industry at the right time and make a little money, but you will never be able to do that consistently as a long-term investment strategy.
As we already discussed in mistake #1, investing is all about long-term thinking, not short-term trading or luck. One of the biggest mistakes you can make is to confuse luck with skill.
If you’re tempted to buy into the next hot stock or idea then plan ahead and only allocate a very small percentage of money from your portfolio as your BINGO money that you would be fine with if you lost it all.
Don’t take unnecessary risks with your serious money that is allocated for your long-term retirement goals.
Dollar-cost averaging without a plan often leads to investment disaster.
Dollar cost averaging into the market is all about developing a consistent strategy for systematically investing new money into the stock and bond markets.
Once you decide that you wish to invest new money into the market you have two choices; the first is to invest the amount in one lump-sum and the second option is to dollar-cost average into the market over a period of time.
Contributing money into your 401(k) plan each time you are paid is known as dollar-cost averaging.
Since you are paid every week, bi-weekly or monthly this becomes your default dollar-cost averaging frequency. You don’t think about it, it just happens.
Where you can begin to get into trouble with dollar-cost averaging is when you begin to think about the next upcoming investment that is scheduled and then deciding not to invest at that time because of market movements, news, or your emotions.
Once you veer off of the systematic approach to investing, you then go to the complete opposite of now timing the market and injecting your emotions into investing, both of which can compromise your long-term investment success.
Stick to your systematic dollar-cost averaging plan and don’t think about whether it’s the right time to invest. Just invest if the plan calls for the next investment.
Getting out of the market because you think it is overvalued or about to go through a correction.
Unless you have reached your investment goals and it’s now time to potentially reduce risk or take risk completely out of your investment portfolio, trying to time the market to determine if it is overvalued or if a correction is looming is yet another emotional and market timing tendency.
You may get lucky in such a market timing call, but the odds are stacked against you.
Just for the sake of discussing this investment mistake, let’s assume that you actually made the correct market timing call and got out of the market before a big correction.
The next correct market timing call you need get right is when to get back into the market.
We have all seen research where if you missed being in the market on specific days or a certain number of days you would have had substantially lower investment performance, but yet marketing timing occurs each day, hour and minute when the markets are open.
Remember for every winner in the markets there is a loser on the other side of the transaction. In other words, you are trying to time the market under a zero-sum structure.
Anyone can buy an index fund. Is it that simple?
If you're not already using index funds in your investment portfolio you might ask yourself how complicated is index investing, don’t I just buy a S&P 500 Index fund and forget about it? Not quite.
There are literally hundreds of different market indices that cover every market, asset class and style of investing that you can imagine. So as you can see, simply buying the S&P 500 Index and calling it quits is not the most prudent approach to index investing.
The S&P 500 Index provides exposure to 500 large cap US company stocks that consist of about half value stocks and half growth stocks.
Since we live in a global economy and the global markets consist of all sizes of companies then your portfolio should have more than just exposure to 500 US large cap stocks for the stock portion of your portfolio. Buying only the S&P 500 Index is not a diversified investment portfolio.
Please spend a little time and understand other asset classes and styles that you can add to your portfolio to help it better represent the performance of the global economy.
Using margin in your investment account.
Using margin (loans) in your investment account can help amplify your returns if you happen to make correct market timing calls or pick the right stocks that perform well, but as we already discussed in several prior mistakes market timing is nearly impossible to consistently employ over the long-term without a great deal of luck.
Margin will leverage your investments to amplify your performance, but at a cost.
The first cost is if your market timing calls are wrong it also amplifies your losses and using margin also carries with it the cost of interest that needs to be paid to the broker-dealer loaning you the money to purchase securities on margin.
With both of those negatives as well as armed with the knowledge that it is nearly impossible to accurately time the markets over the long-term make using margin in your account a danger that you don’t need that could crush your investment goals.
If you are someone who needs to have some excitement with your investments and want to try and time the markets using leverage, you can simply purchase leveraged ETFs without having to get into margin investing that carries interest and potential margin calls requiring you to deposit additional funds into your account if your securities that are purchased on margin fall in value.
Buying tax inefficient investments in your taxable accounts.
There are often many things that you are thinking about before purchasing an investment, but one important thing to consider is the type of account where certain types of investments should be held based on the tax status of an individual investment.
The placement of certain types of investments in certain types of accounts based on tax implications is known as asset location.
Properly allocating assets among different accounts can further help minimize the amount lost to taxes each year. Some of the basic things to consider with asset location is to place more of your equity investments in after-tax taxable accounts and place more of the bond portion of your portfolio in your retirement accounts.
By placing equity in your taxable accounts you can enjoy potentially lower long-term capital gain tax rates when you sell investments at a gain to rebalance your portfolio.
Since bond interest is taxed at ordinary income tax rates it makes sense to place more bonds in your retirement accounts because your retirement accounts are taxed at ordinary income tax rates when you are required to being taking Required Minimum Distributions (RMDs) from your retirement accounts at age 72.
Buying municipal bonds when you don’t need them. Let’s do some math.
Choosing to purchase municipal bonds over taxable bonds for the bond portion of your portfolio that will be held in after-tax taxable accounts is a simple math calculation.
If you are in or just entering the 28% marginal federal tax bracket then you may want to sit down with a calculator or discuss with you accountant the potential advantage of purchasing municipal bonds over taxable bonds in your taxable accounts.
The following calculation is called the Tax-Equivalent Yield(TEY) formula:
Municipal Bond Yield / (100% minus your tax rate) = TEY
So let’s use an example: Let’s say you are looking at purchasing municipal bonds with a yield of 2.0% and your marginal tax rate is28%. You are trying to decide on a pre-tax basis if you should purchase municipal bonds or taxable bonds that are yielding 2.5%.
The formula would be calculated as follows:
0.02 / (1 - 0.28) = 0.0278 or 2.78%
In the example calculation above you would receive the taxable equivalent yield on the municipal bonds of 2.78% versus the pre-tax yield of 2.5% for the taxable bonds. In this example you would likely purchase municipal bonds in your taxable accounts because the taxable equivalent yield of 2.78% is higher when compared to the pre-tax yield on the taxable bonds of2.5%. So, in this example your yield would be 0.28% higher with municipal bonds.
One last thing...never purchase municipal bonds in your retirement accounts.
This is not tax advice so please check with your tax advisor.
Not committing to a single investment philosophy.
With the proliferation of index funds over the last ten years its safe to say you may hold both index funds and actively managed mutual funds in your investment accounts.
Sometimes the mixture of the two types of investment philosophies happens without any investment plan or strategy to include both and other times it happens because you wish to have both passive and active investment philosophies in your portfolio.
Mixing both active and passive investment management philosophies is often called “core and explore” or “core and satellite” investing.This type of approach sounds good in theory, but it often fails in implementation and management because it has a tendency to fall victim to market timing, chasing returns and allocating your investments to those that have performed well, whether it be active management or indexing.
It’s best to do some soul searching and determine if you agree more with index investing or more with active investing strategies.
Selecting an investment philosophy is like selecting a religion. You settle on one that best fits your beliefs and then go all-in.
Using the bucket approach for your investment strategy.
You may have read or heard about the concept of investing using the “bucket” approach. This approach is easy to understand, but complex to implement and maintain.
The basic concept is to take your total investment assets and divide your assets into three buckets based on time horizon of when you need income from your portfolio.
The typical bucket approach has one bucket for short-term needs (years 1-3), one for intermediate-term needs (years 4-9) and one long-term needs (years 10+).
The idea is allocate mainly cash to your short-term bucket, bonds to your intermediate-term bucket and stocks to your long-term bucket.
This approach is 100% for psychological reasons in how you may wish to view your money. It has no actual portfolio management advantages.In fact, this approach is often marketed by investment advisors and brokers asa way to differentiate themselves from other advisors.
Where things become complex is trying to manage three buckets and then replenish one bucket from another as one bucket becomes depleted. Again, this sounds great in theory, but not in reality.
Since no one knows how the markets will perform it makes trying to adhere to this strategy emotional, when the entire premise behind the concept is to help you minimize or eliminate the emotional impact when the markets decline.
Falling in love with your investments or holding them for sentimental or nostalgic reasons.
One of the worst things you can do is put blinders on and hold any of your current or legacy investment positions for sentimental or nostalgic reasons when they no longer fit into your investment plan designed to reach your investment goals.
This occurs most is in situations where a spouse handles the investments and then passes away leaving the surviving spouse who was not typically involved in managing their investments now left to manage them.
The typical inclination of the surviving spouse is to to keep all of the investments because they think that is what their spouse would have wanted. Death and investing are both extremely emotional and when you put both together bad decisions can be made quickly that have long-term consequences that could completely destroy a portfolio.
Usually, the best course of action is not to make any investment or money decisions for 3-6 months after a major event, depending upon the situation.
Withdrawing too much or too little from your investment portfolio to meet your retirement income needs.
Determining how much is safely withdraw from your investment portfolio is always a stressful decision. There have been many studies done on safe withdrawal rates over the years and there is no clear cut answer, only a bunch of ideas and rules of thumb.
The most widely referenced safe withdrawal rate is around 4%of your portfolio value. Since your needs are different than another person’s needs, using a standard rule of thumb can lead to potentially taking too much out of your portfolio and even eventually running out of money.
Also, the opposite can occur, by taking too little out of your portfolio could lead to you not enjoying all that retirement has to offer when you are in your early years of retirement and are in your best health.
We have found that the best approach is to start by determining how much income you will actually need from your portfolio to do the things you want to do in retirement.
Once your income needs are known, then you will need to calculate what percentage that figure is of the current value of your investment portfolio.
If the withdrawal percentage is more or less than some of the rules of thumb such as 4% then you will need to spend some time understanding why it is higher or lower and potentially make adjustments to your lifestyle, portfolio risk, retirement age, income needs, etc.
You should not have to sacrifice in retirement, nor do you want to be the richest person in the graveyard. Spending some time understanding the levers that can be adjusted will help lead to a less stressful retirement.
Buying into mutual fund year-end capital gain distributions.
Investing in mutual funds and some ETFs in December can cause your tax bill to be higher.
December is the typical month that mutual fund companies and some ETFs make year-end capital gain distributions. If you plan on investing new money in December of any calendar year you should try and avoid buying into a year-end distribution.
You can avoid this by making your new mutual fund purchases after the distribution date (payment date) or ex-dividend date. This way you avoid purchasing an investment and then immediately receiving a year-end capital gain distribution that you will immediately owe taxes on for the current tax year.
Remember taxes are an investment cost and you should try to minimize your taxes if possible and by avoiding buying into year-end capital gain distributions is a very simple way to minimize your taxes.
Investing in gimmicky ETFs disguised as index funds.
With the proliferation of ETFs over the last 10 years many of the ETFs available for purchase today are not traditional index funds even though issuers would like for you to think they are.
Just because an ETF follows a made-up index does not make them index funds in the traditional sense of the term index fund.
Many of the indices that ETFs track are often made-up indices that can range from the Quincy Jones Streaming Music, Media &Entertainment ETF (currently in registration with the U.S. Securities and Exchange Commision as of the date of this article) claiming its investment approach is “IconicBeta”(what?) or The Obesity ETF and everything in-between, including leveraged ETFs.
Unfortunately, ETF investing has become an active investing swamp. If you’re you’re trying to adhere to a index based investment philosophy do your homework and stick with traditional index funds.
Remember, most of these active forms of ETFs are nothing more than active investment managers to extract high fees from your investment portfolio. Know what you are buying. The name of a fund does not tell you much.
Not paying attention to the spreads when buying or sellingETFs.
Unlike mutual funds, ETFs trade throughout the trading day.This makes it nearly impossible to consistently buy or sell ETFs at Net AssetValue (NAV).
If you’re a long-term, buy, hold and rebalance investor whois not investing new cash on a regular basis then this is not too much of an issue. However, if you are dollar-cost averaging into the market regularly or are frequently investing new cash then ETFs can present a challenge with bid/ask spreads from its Net Asset Value (NAV).
Since ETFs trade throughout the day you never know what the exact NAV of the ETF is at the exact moment of the trade. This can lead to you buying ETFs above NAV, where with a mutual fund, the purchase price is the NAVat market close.
Therefore, if you will plan to make frequent investments into ETFs it may make sense to look to mutual funds to avoid losing long-term performance to bid/ask spreads.
Buying or selling ETFs near the open or close of the markets.
As explained in mistake #36, ETFs have bid/ask spreads from its NAV. When buying or selling an ETF you want to try to the price to be as close to its NAV as possible, which occurs by minimization of bid/ask spreads.
Since the markets are the most volatile at the open and close of the market day you should try to avoid buying or selling any ETFs in the first 30-60 minutes of the market opening and the last 30-60 minutes of the market closing in an attempt to minimize bid/ask spreads.
Investing in something you don’t understand.
This mistake is very straight-forward and should not require much explanation. It speaks for itself, but just to reiterate, if you don’t understand the investments that you’re considering buying, then don’t buy them.
Also, if you don’t understand the investment, it is also likely you won’t understand how it’s going to help you meet your investment goals written in your investment plan.
Usually the more complicated an investment is, the higher the investment costs and lower the performance.
Investing does not need to be complicated - Wall Street makes it complicated.
Failing to take Required Minimum Distributions (RMDs) from your retirement accounts.
A very common mistake that you can easily overlook is not taking the IRS Required Minimum Distributions (RMDs) from your retirement accounts at age 72 and each year thereafter.
This is the age the IRS forces you to begin taking annual distributions from your tax-deferred retirement accounts that are consistent with your life expectancy using actuarial tables.
RMDs need to be taken from your retirement accounts whether you need the income or not. If you don't need the income you can simply take the RMD and move the distribution amount into one of your after-tax taxable accounts.
Failing to take your RMD annually could cost you significantly in penalties. The amount of your RMD is taxed as ordinary income, but your failure to take an RMD is also assessed with a 50% penalty of the amount that should have been distributed.
To use an example, if your marginal tax bracket happens to be 28% then you could potentially lose up to 78% (28% ordinary taxes and 50%penalty) of the amount you failed to take in distributions. This is a big mistake that is easily avoidable with a minimal amount of planning.
Taking too much, too little or the wrong type of investment risk.
One of the keys to long-term investment success is to understand how much investment risk you need to take with your investment portfolio to reach your investment goals.
In order to determine an appropriate level of investment risk you first need to document your investment goals and what your required rate of return is to meet those goals over a certain period of time.
Once you know your required rate of return you can then back into the minimum level of investment risk you need in your portfolio in an attempt to reach your investment goals.
Any investment risk you take above the minimum amount required is simply just investment risk you want to take in the hopes of attaining even higher returns, albeit with higher risk.
Frequently checking your investments.
With all of the conveniences of modern technology it possible to always have your hand on the pulse of the markets and have immediate access to your investment account balances and as much detail about your investments that you desire. This is both good and bad.
The bad part is by constantly checking your account balances or individual investment holdings you begin to think about your investments through a short-term lens rather than long-term lens.
This can lead to making sporadic and emotional investment decisions that are inconsistent with your investment plan and goals.
The next time you think about checking your account balances and holdings think about this famous Warren Buffett quote:
“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
Overestimating your return expectations from the markets.
Using unrealistic market return expectations for your investment plan can easily be a sure fire way to mess-up your investment goals.
When you develop your asset allocation strategy within your investment plan be sure to use conservative and realistic market forecast expectations, not blindly looking at past performance of your investment selections and using those figures as forward looking expectations.
This can set you up for failing to save enough or having to work longer than you anticipated because your future market expectations are too lofty.
Waiting until the market “settles down” before investing new money.
It’s hard to figure out what this even means, but we hear it all the time in volatile markets. At what point are the markets settled? Never.
Markets are always in motion. There is never a time when markets settle down. You are best served by trying not to time the markets as we have mentioned as some of the prior mistakes.
If you’re investing using index funds for your investments then the best time to invest new cash is when you receive it.
Don’t waste your time trying to figure out when the markets are going to settle down. This is an emotional exercise that has no correct answer with a specific date or time.
Overconfidence in your ability to manage your portfolio during a market decline or bear market.
If you’re a Do-It-Yourself (DIY) investor, then you’ll likely agree that managing your investment portfolio when the market has gone up or during long bull markets is a lot easier than in bear markets or during market declines.
That’s because in a bull market, investing often requires less emotional decisions that need to be made.
In bear markets or market declines you become significantly more emotionally invested in each investment decision because you are losing real money (on paper, unless you sell).
What happens is your confidence is artificially inflated during bull markets because you're making money and then you head into a bear market or market decline with the same confidence, which often leads to quick and overconfident decision making.
Taking a distribution from your 401(k) plan rather than rolling over your 401(k) plan assets into an IRA Rollover account.
Switching jobs or retiring can often be stressful periods of time. You are starting something new in both instances and now having to make money decisions in those stressful times can lead to bad or unwanted outcomes.
One of the single most important decisions you must make when you switch jobs or retire is what to do with your 401(k) plan assets. This decision should not be an afterthought, because it can cost you significantly if you make the wrong decision.
Under most circumstances you will always want to move your401(k) plan assets into an IRA Rollover account using a “direct rollover”approach. You never want to take a “distribution” from your 401(k) plan.
Taking a distribution from your 401(k) plan will cause you to have to pay federal and state income taxes on the entire distributed amount as ordinary income using ordinary tax rates.
The majority of the time the paperwork required by your employer when you switch jobs or retire is a single combined form that has options for either a “direct rollover” or a “distribution”.
Please read the forms carefully and don’t confuse the two methods as meaning the same thing.
Relying on rating systems to determine which investments to buy or sell.
There are an overwhelming number of rating systems, market timing systems and newsletters that peddle advice and recommendations on which stocks, mutual funds and ETFs to buy and sell.
If you use or plan on using one of these types of systems be sure you are aware of the methodologies for the advice and recommendations they dispense.
For instance, just because a mutual fund has 5 stars from a rating system or newsletter does not necessarily make it a good investment. It simply means that the past performance of the mutual fund was good.
Remember past performance is not an indicator of future performance.
No one knows what the future holds, but a lot of people and companies make a lot of money trying to convince you they know the future.
Overestimating your tolerance to handle investment risk.
A lot of investment advisors and brokers use risk tolerance questionnaires with their clients to help determine someone's maximum tolerance for risk.
The problem with risk tolerance questionnaires is that they are only reliable at the time you completed the questionnaire.
Your mindset will often change regarding your ability and desire to accept investment risk in your portfolio. But, regardless of what risk tolerance questionnaire you may use, your mindset and feelings towards risk will always be more optimist in bull markets than in bear markets or during market declines.
Therefore, if you use any risk tolerance questionnaires to help assess your tolerance for risk, please proceed cautiously and rely more on the amount of investment risk you need in your portfolio in attempting to reach your investment goals, rather your maximum level of risk a questionnaire is designed to capture.
In search of the “perfect” investment plan.
When it comes to designing a perfect investment plan, there is no such plan. The best you can do is come up with a “good” investment plan.
You’ll never have the “best” or “optimal” investment plan except at the exact moment you write it and then the market opens and your“best” or “optimal” investment plan becomes simply a “good” plan.
Don’t agonize over fractional percentages of how much you should have allocated to one asset class or investment over another. This is a complete waste of time and often leads to analysis paralysis.
Buying closet index funds.
A closet index fund is an actively managed mutual fund that holds individual securities that track the performance of a specific benchmark index, but with higher costs than a traditional index fund.
In other words, closet index funds are funds that are actively managed and the managers don't want the fund to have too much tracking error from its benchmark index, all while still claiming the fund is actively managed in order to charge high investment management fees.
Please spend a few minutes and take a look at the underlying investments held in your mutual funds to determine if you have a closet index fund where you might have an opportunity to reduce your investment fees by switching to true traditional index funds that can be lower cost.
Making your investment plan and investment selections too complex.
When you started out investing you didn't try and overly complicate your investment portfolio, it just happens over time for many different reasons.
The key is for you to recognize that your investment portfolio has gotten complicated and to do something about it.
If you own more than ten mutual funds or exchange traded funds (ETFs) in your portfolio then things are already beginning to get complicated.
Owning more than ten funds usually is the beginning of duplicating the same exposure with multiple funds for the same asset classes in the portfolio. This is often unnecessary, expensive and difficult to manage and can lead to lower performance.
Today is as good of day as any to start pairing back any duplicate investments that you may have in the asset classes in your portfolio in order to simplify your portfolio, reduce your investment costs and have less stress in making financial decisions. Investing does not have to be complicated!
Not all of the investment mistakes mentioned in this article will apply to your specific financial situation, but if you can avoid even one of the mistakes, then you are moving your investment portfolio and decision making in the right direction.