17 Common Investing Pitfalls and Their Remedies

The following is an excerpt from The Secret Language of Money: How to Make Smarter Financial Decisions and Live a Richer Life and lists 17 common investing pitfalls and their remedies.

1. Not having a master plan informed by expert information and knowledge.

Rx: Design your own plan. Be sure you and your system are a comfortable fit. Not having a plan leaves you vulnerable to hot tips and emotional decisions. An objective, structured game plan includes goals, strategy, target points of date or money, regular (in time periods and/or dollar amounts) contribution to a savings and retirement fund.

2. Not regarding investing as a business.

Rx: You are the CEO of your finances. What you do with your money is at least as important as how you obtain it. Investing is a business requiring the expenditure of time and money to yield return.

3. Not using others’ knowledge and expertise.

Rx: If you don’t already have one, find a financial advisor whom you trust, and review your plan with him or her regularly. Base this review on a predetermined calendar time (once a year, quarterly, etc.) rather than as precipitated by an emotional event. Also consider forming a personal or business board of advisors or mastermind group to help brainstorm your financial plans.

4. Inconsistently adhering to your plan.

Rx: Having a plan is half the battle; sticking to it is the other. When things are going very well or very badly—such as a bull or bear market, or a spectacular rise or fall of your stock—resist the pull to act. It is at times of strong emotional stimulation that your brain and mind have difficulty not reacting. In a rocking boat, one effective way to avoid seasickness is to focus on a fixed point on the distant horizon. Your financial plan is that fixed focal point, especially in times of storm. Keep your plan clearly in view, and stick to it, especially when you are most tempted to abandon it.

5. Acting on someone else’s formula, methodology, or system.

Rx: Set and prioritize your own goals. Clarify the resources you have available and identify the potential obstacles. Develop your own principles and objectively monitor your progress at regular intervals.

6. Blaming others for your mistakes.

Rx: Own your decisions. Don’t shoot the messenger, blame the broker, or fault the floor trader. When you admit your mistakes, you recognize the choices as yours, which puts you in charge. With ownership comes the capacity to avoid repeating the same mistakes.

7. Setting goals to get rich quickly.

Rx: Fear and greed, the greatest enemies of any investor, lie within all of us. Patience and persistence are an investor’s best friends.

8. Being overconfident in your ability to pick stocks.

Rx: Be willing to admit mistakes, let go of losers, and recognize that success in one business arena may not transfer to success in another (investing).

9. Failing to diversify.

Rx: Wall Street Journal personal finance columnist Jason Zweig concludes from his research that diversification “is the single most powerful way to prevent your brain from working against you.” Remember Enron. Remember Marsh and McLennan. Spread your savings and investment money around different investments.

10. Not designating separate portions of your portfolio for calculated risk and for secure, no-risk investment.

Rx: Like our perceptions of middle age and old age, our perception of what is risky changes as we approach it. Consider maintaining at least three piles of money: one for long-term retirement, one for value and growth investing, and one for speculative, aggressive growth—your gambling pile. Having a gambling pile insulates serious money from the vagaries of your amygdala and the yearnings of your dopamine receptors.

11. Acting without full emotional acceptance of the decision.

Rx: If any part of you disagrees with what you are about to do, you will not be able to make a full commitment. Delaying a decision is better than acting on a half-hearted commitment.

12. Becoming paralyzed by the fear of losing money.

Rx: Distinguish how much you can emotionally afford to lose, as well as how much financially you can afford to lose. Note the difference.

13. Hoping that a stock will return to its former level.

Rx: Clinging to this continued hope may be a bad business decision. For a stock to return to break even after dropping, say, from $80 a share to $15, it would have to significantly outperform the market by growing at a rate of 15 percent every single year for 12 years straight.

14. Being unwilling to cut losses short.

Rx: We naturally abhor losses and want to disregard them, holding onto the hope of reversal. When you cut a loss short by selling, you acknowledge it and make it real. This may seem painful, but is good: Ignoring reality can be expensive.

15. Putting energy into things you can’t determine.

Rx: Focus on what you can determine; accept and let go what you cannot. Focus on facts rather than feelings—a counterintuitive move at a time when feelings run high. Avoid frequent market monitoring to reduce exposure to reaction-producing (positive or negative information). Minimize emotion by having sound principles and a well-thought-out system in place.

16. Disregarding stress.

Rx: Take a self-inventory at regular intervals. At stressful times, refrain from making significant decisions until you are calm and objective. Create a daily relaxation or meditation ritual.

17. Making decisions on impulse.

Rx: Remember that there are few genuine emergencies in life, and investing isn’t one of them. An appeal for instant action, a short-fuse deadline, or to get in quickly with a “chosen few” should all be pondered and researched. At the same time, getting stuck in a holding pattern of perpetual research and postponement can turn into avoidance of action, which may be fueled by the wish to avoid anticipated negative consequences. Make your decisions carefully—but make them.

Comments

[Eugene Krabs]

Good list! Thanks for sharing.

[Glenn Sojourner]

Your posting is so right. It's just like anything in life...thought, decision, plan and action. It is the only way to anything worthwhile whether it's investing, building a business, even planning a vacation.

Thanks for the post!

[Mike]

18. If you don't want to spend time worrying about stocks then research a suitable blend of stocks and bonds for your risk tolerance. Purchase respective indexes in that ratio and only sell them if you personally need the money for some non-stock life event(retirement, illness, new house) and then only if absolutely necessary.