Investing flubs: Don’t repeat after me

The following is an excerpt from “Investment Discipline: Making Errors Is OK, Repeating Errors Is Not OK” by Reto R. Gallati (Balboa Press, 2012).

Making mistakes is human. Investors are only human, and sometimes we let our feelings lead us off track. Even savvy investors can make these mistakes.

Investing is all about learning from your own experience, or screw-up, or from others’. When you look at financial advisers, check their scalps. If there are any gray hairs or a bald spot, it means they have been around long enough to see financial cycles. If you are really lucky, they have already screwed up a few times at someone else’s expense, so they know the score.

The pain of losing is greater than the pleasure of winning. That is why you should always start your examination of an investment by examining the potential downside. It all boils down to risk/reward. Unfortunately, it takes a while to learn this lesson. That is the difference between a risk worth taking and a sucker’s bet.

The last and most critical mistake an investor who is just starting out can make is giving up on investing altogether after taking a hard (but not critical) hit. There is a good possibility that if you avoided the mistakes I made and write about here, your clients’ portfolios would not suffer a big drop, but as any student of risk management will tell you, fat-tail risks tend to occur more often than people expect.

Over the past few decades, we’ve had a major event every three to four years. If we include blowups on a company level, we have them every week. There are plenty of examples in the markets and our own experience to learn from and get smart.

The saying “once bitten, twice shy” is a double-edged sword. We can become overly shy from bad experience, and close ourselves off and shun any risk. On the other side, it offers the opportunity to go back with experience and, most likely, a slightly more conservative approach. Over and over again, I have come across people who lost a bunch of money in a bear market and decided to become highly conservative, even though they were years or decades from retirement. This has led them to stay out of the market during their best years and earn subpar returns.

THE WORST MISTAKE IS NOT LEARNING

If you cannot remember now what your worst investing mistake was, you obviously did not learn.

That means the pain of losing money was not serious enough. You are either so rich that you can afford to lose money without remembering or you just bought the best book to improve your investment skills

New investors often do not understand that the opportunity cost of staying out can be much higher than staying invested and taking an occasional hit. Investors shying from the pain will not learn.

Individuals often fail to begin an investment program simply because they lack basic knowledge of where or how to start. Likewise, periods of inactivity are frequently the result of discouragement over previous investment losses or negative growth in the equities markets.

To be certain, investors should continue investing in every market — albeit through different investment vehicles — and establish a mechanism to make regular contributions to their portfolios. Advisers’ should also regularly review their clients’ holdings to ensure they are adhering to the overall strategy.

HOW CAN I AVOID SOME OF THE MISTAKES?

Learn from the best. Read the classic investing books and talk to trustworthy individuals.

Don’t be afraid. You really do not need a graduate degree in finance to enjoy success in your investing endeavors. Simple, basic knowledge is a powerful tool. The purpose in becoming familiar with these fundamental investing concepts is to remove fear from your decision-making process. Once you have a grasp of the way they operate, you will be able to take a more active, informed role in the direction of your clients’ portfolios and, ultimately, your financial future.

Read and educate yourself. The more you know, the better you can manage investments. Read the financial pages and books, and listen to financial newscasts. Avoid getting duped and sidetracked by hype and hard sell. Many books, articles and online resources have been written on investing. Many can guide you to smart decisions; some can change your life. The more you know, the better you can manage investments.

Think intellectually, act intellectually. It is one thing to develop a sound portfolio, and another to stay with it when the markets falter. Most people are motivated by emotion based on short-term variables and the latest news. Success in market investing requires patience and stamina. Making short-term moves generally is a prescription for disaster. Most investors have little faith that the markets will rebound, so they sell at the bottom, converting a paper loss to a real loss in the hopes of saving money. You pay a high price for a rosy consensus. By waiting for everyone to agree if it is OK to invest, you are likely to buy at market highs.

Tell your clients to let compounding do the work. Most people understand the importance of saving but do not appreciate the impact of starting now. An investor earning 10% would see $100,000 grow to $1.6 million in 28 years. Waiting 10 years would require $287,000 to achieve the same result.

Understand the investment. If you do not understand an investment, do not put your money into it. I believe this single step will prevent more grief than almost anything else you can do. Understanding your investments is a form of learning.

Slow down, do not resign. Sometimes the best course is simply to slow down. Take a deep breath, and apply a liberal dose of patience.

Make it fun. If you like learning, then it is easy. View active investing as a learning experience, and the process will not feel burdensome. It should be a pleasurable experience, and it is up to you to find ways to make it fun. Practice with an online broker who charges low per-trade fees and requires no minimums. However, spending so much time focused on investments that real life gets crowded out is too much.

INVEST IN YOURSELF

Good retirement planning involves a lot more than just managing your money properly. Smart people take care of their health, both mental and physical. Smart people cultivate new relationships and nurture established ones. The happiest retired people I know are those who seem to have many favorite people in their lives, including people who are younger than they are.

Do the same: Reach out and build networks. In the same way as you establish relationships, you will be able to discuss your investment themes and receive feedback and insight into what your friends are doing.

Reto Gallati is president and founder of Raetia Investments LLC, a private investment and trading company.