I play tennis and have for many years. I also have a very competitive nature and really hate to lose, especially when I believe I “gave” a match away; that I made too many mistakes. All too often in tennis, these mistakes are the result of unforced errors. So for many tennis players, the major part of their game that they need to work on is unforced errors. Let the other guy or gal make the mistakes. You be the player that stays away from the causes of these errors and increase your chances of walking away the winner.
Sitting in my office and reliving a recent tennis loss, it occurred to me that unforced errors not only occur in tennis, but in investing as well. Many investors fall prey to investing mistakes that cost them not only money, but peace of mind. Much of the time, these mistakes can be classified as unforced errors.
I’ve come up with a list of what I’ll call common unforced errors that can cost an investor a big win. I’m certain that this list is not all inclusive, but working on these can certainly improve your financial performance. Think seriously about causes and consequences and begin to work on eliminating your investment unforced errors.
Don’t we all fall for this at times? I believe it can be likened to greed. We want to invest in the next Apple or Amazon. We listen to the retelling of the stories of the handful of people that made it big with this type of investment and think, it could have been me. Why not me? One right pick and I’m set for life. Unfortunately these big winners only happen every so often, and you have to stay the course through ups and downs. And what happens if in your chase you never hit that next Apple or Amazon? Opportunities lost. Shucks!
So you have selected a number of companies, say 5, in hopes that you picked the next Apple or Amazon. But that’s okay if you didn’t. You fully expect to hold your positions and then at an opportune moment, sell them at a higher price. These are growth stocks and don’t pay a dividend and that’s okay. Of course, you don’t know exactly when to sell them as they are heading up, but surely they won’t head down. Let’s say you bought these positions in 2003 and will need to sell them to pay for college for your three kids in 2008. What about your hopes for selling at a higher price? The company stocks have done very well from purchase to 2007, but in 2008 when you need to cash out with a gain, the stocks are worth less than your original purchase price and you didn’t get paid along the way. Ouch!
So you found other money to pay for your kids’ education in 2008 and decided to hold on to your stocks; even though you have done some research and three of the five companies aren’t expected to do well in the future. You don’t want to sell them because of Anchoring. Anchoring is a bias where we look at our purchase price for making future decisions. You bought these stocks at $X/share and the share price at the moment is less. You don’t want to sell at a loss even though expectations are that the share price is going to continue a downward trend. Other investors don’t care what price you paid for your stocks. They are looking at the objective fair value and future total return potential of the company; and you are left holding some losers. Oops!
Relying too heavily on our purchase price is based on emotions. You don’t want to believe you made a mistake. Certainly the stock prices will go back up and you will be able to sell them for gain, just like you planned. But maybe they won’t. Let’s say that all of a sudden, the market starts to trend downward again. The news is bad. Your co-workers are moving into bonds and cash. You begin to think you can’t afford to lose any more on your investments. You sell all of your stocks at a very low price, even the two that still have very positive outlooks. You have let your emotions rule your decisions, just like the majority of investors. You have fallen into a sell low and buy high cycle. Oh my!
Your poor, personal historical investment results have led you to become a very conservative investor and you really don’t like market fluctuations at all. You are invested in individual bonds, so you know you will get your money back as well as the stated quarterly income. You are well invested according to your risk tolerance. But wait, the bond interest rates aren’t even close to keeping up with inflation, and you actually need a net growth of about 4% annually to make it through life. Maybe risk tolerance doesn’t address at all what you need and how you should be investing. What makes you more uncomfortable, investing in the market with reasonable expectations of earning the growth you need and staying ahead of inflation although there is volatility, or sleeping well at night knowing that your bonds are not going to lose value and will pay you some interest? Of course you have to take into consideration that you wake up every hour or so with the realization that your nest egg’s diminishing purchasing power is not going to be your friend. Ugh!
The market is growing pretty well. You are selling your shares of stocks and bonds to create the supplemental income you need. What can go wrong? Well it is 2008 again and the market isn’t playing nice this year. Your nest egg is down 40%. Unfortunately your supplemental income need is the same as last year. You are going to have to sell a larger number of shares of your stocks and bonds to create that same supplemental income. What impact does that have on your long-term success? The sequence of returns may not be your friend year after year using this strategy. Alas!
You’ve run the numbers every which way. No one in your family has lived past 80 years of age. You have your nest egg in laddered short term CDs. Your money should last easily through age 82, and you don’t plan on being around then. But what if you live; and quite a number of years longer; and the Cost of Living Adjustments for your Social Security benefit don’t go up much although inflation is averaging 2.8%? Tragic!