10 Investing Obstacles to Conquer - dummies

10 Investing Obstacles to Conquer

By Eric Tyson

“Success” with personal investing is in the eye of the beholder. A successful investor is someone who, with a modest commitment of time, develops an investment plan to accomplish financial and personal goals and who earns competitive returns given the risk he’s willing to accept. Here are ten common obstacles that may keep you from being successful and fully realizing your financial goals.

Trusting authority

Some investors assume that an advisor is competent and ethical if she has a lofty title (financial consultant, vice president, and so on), dresses well, and works in a snazzy office. Unfortunately, such accessories are often indicators of salespeople — not objective advisors — who recommend investments that will earn them big commissions that come out of your investment dollars.

If you overtrust an advisor, you may not research and monitor your investments as carefully as you should. Too many investors blindly follow analysts’ stock recommendations without considering the many conflicts of interest that such brokerage firm employees have. Brokerage analysts are often cheerleaders for buying various companies’ stock because their firms are courting the business of new stock and bond issuance of the same companies. And just because a big-name accounting firm has blessed a company’s financial statements (Enron) or a company’s CEO says everything is fine (Bear Stearns) doesn’t make a firm’s financial statements accurate or its conditions sound.

Getting swept up by euphoria

Feeling strength and safety in numbers, some investors are lured into buying hot stocks and sectors (for example, industries like technology, healthcare, biotechnology, retail, and so on) after major price increases. Psychologically, it’s reassuring to buy into something that’s going up and gaining accolades. The obvious danger with this practice is buying into investments selling at inflated prices that will soon deflate.

Develop an overall allocation among various investments (especially diversified mutual funds), and don’t make knee-jerk decisions to change your allocation based on what the latest hot sectors are. If anything, de-emphasize or avoid stocks and sectors that are at the top of the performance charts.

Being overconfident

Newsletters, books, blogs, and financial periodicals lead investors to believe that they can be the next Peter Lynch or Warren Buffett if they follow a simple stock-picking system. The advent of the Internet and online trading capabilities spawned a whole new generation of short-term (sometimes even same-day) traders.

If you have the speculative bug, earmark a small portion of your portfolio (no more than 10 to 20 percent) for more aggressive investments.

Giving up when things look bleak

Inexperienced or nervous investors may be tempted to bail out when it appears that an investment isn’t always profitable and enjoyable. Some investors dump falling investments precisely when they should be doing the reverse: buying more. Sharp stock market pullbacks attract a lot of attention, which leads to concern, anxiety, and, in some cases, panic.

Investing always involves uncertainty. Many people forget this, especially during good economic times. Investors are more likely to feel comfortable with riskier investments, such as stocks, when they recognize that all investments carry uncertainty and risk — just in different forms.

Larger-than-normal market declines hold a significant danger for investors: They may encourage decision-making that’s based on emotion rather than logic. Just ask anyone who sold after the stock market collapsed in 1987 — the US stock market dropped 35 percent in a matter of weeks in the fall of that year. Since then, even with the significant declines in the early and late 2000s, the US market has risen about fifteen-fold!

Refusing to accept a loss

Although some investors realize that they can’t withstand losses and sell at the first signs of trouble, other investors find that selling a losing investment is so painful and unpleasant that they continue to hold a poorly performing investment despite the investment’s poor future prospects. Psychological research backs these feelings — people find the pain of accepting a given loss twice as intense as the pleasure of accepting a gain of equal magnitude.

Analyze your lagging investments to identify why they perform poorly. If a given investment is down because similar ones are also in decline, hold on to it. However, if something is inherently wrong with the investment — such as high fees or poor management — you can make taking the loss more palatable:

  • Remember that if your investment is a non-retirement account investment, selling at a loss helps reduce your income taxes.
  • Consider the opportunity cost of continuing to keep your money in a lousy investment. In other words, what returns can you get in the future if you switch to a “better” investment?

Over-monitoring your investments

The investment world seems so risky and fraught with pitfalls that some people believe that closely watching an investment can help alert them to impending danger.

Investors who were the most anxious about their investments and most likely to make impulsive trading decisions were the ones who watched their holdings too closely, especially those who monitored prices daily. The proliferation of Internet sites and stock market cable television programs offering up-to-the-minute quotations gives these investors even more temptation to over-monitor investments.

Restrict your diet of financial information and advice. Quality is far more important than quantity. Watching the daily price gyrations of investments is akin to eating too much junk food: Doing so may satisfy your short-term cravings but at the cost of your long-term health. If you invest in diversified mutual funds and exchange-traded funds, you really don’t need to examine your fund’s performance more than twice per year. An ideal time to review your funds is when you receive their annual or semi-annual reports.

Being unclear about your goals

Investing is more complicated than simply setting your financial goals and choosing solid investments to help you achieve them. Awareness and understanding of the less tangible issues can maximize your chances for investing success.

In addition to considering your goals in a traditional sense (when you want to retire and how much of your kids’ college costs you want to pay, for example) before you invest, you should also consider what you want and don’t want to get from the investment process. Do you treat investing as a hobby or simply as another one of life’s tasks, such as maintaining your home? Do you enjoy the intellectual challenge of picking your own stocks? Don’t just ponder these questions on your own; discuss them with family members, too — after all, you’re all going to have to live with your decisions and the investment results.

Ignoring your real financial problems

You may be tempted to think that you can’t save if you don’t earn a high income. Even if you’re a high-income earner, you may think that you can hit an investment home run to accomplish your goals or that you can save more if you can bump up your income. This way of thinking justifies spending most of what you earn and saving little now. Investing is far more exciting than examining your spending and making cutbacks.

Overemphasizing certain risks

Saving money is only half the battle. The other half is making your money grow. Over long time periods, earning just a few percent more makes a big difference in the size of your nest egg. Earning inflation-beating returns is easy if you’re willing to invest in stocks, real estate, and small businesses. The figure shows you how much more money you’ll have in 25 years if you earn investment returns that are greater than the rate of inflation (which historically has been about 3 percent).

Slightly higher returns compound to really make your money grow.

Ownership investments (stocks, real estate, and small business) have historically generated returns that are 6 or more percent greater than the inflation rate, while lending investments (savings accounts and bonds) tend to generate returns of only 1 to 2 percent greater than inflation. However, some investors keep too much of their money in lending investments out of fear of holding an investment that can fall greatly in value. Although ownership investments can plunge in value, you need to keep in mind that inflation and taxes eat away at your lending investment balances.

Believing in gurus

Stock market declines, like earthquakes, bring all sorts of prognosticators, soothsayers, and self-anointed gurus out of the woodwork, particularly among those in the investment community, such as newsletter writers, who have something to sell. The words may vary, but the underlying message doesn’t: “If you had been following my sage advice, you’d be much better off now.”

People spend far too much of their precious time and money in pursuit of a guru who can tell them when and what to buy and sell. Peter Lynch, the former manager of the Fidelity Magellan Fund, amassed one of the best long-term stock market investing track records. His stock-picking ability allowed him to beat the market averages by just a few percent per year. However, even he says (as does investment legend Warren Buffett) that he can’t time the markets. He also acknowledges knowing many pundits who have correctly predicted the future course of the stock market “once in a row”!