investing

Big investment boo-boos individuals make

Professors' Profiles

Jill Foote, CFA, Ph.D.


Title:
Senior lecturer in finance

School:

Steven Dolvin, CFA, Ph.D.

Title:
Associate professor of finance

School:

Todd Feldman, Ph.D.

Title:
Associate professor of finance

School:

What is the single biggest mistake you see individual investors make?

Jill Foote, CFA, Ph.D.

AnswerThe single biggest mistake individual investors make comes from poor market timing, particularly in exiting (selling) positions. Individual investors have a tendency to hold winning and losing positions too long. In the worst case, investors hold a losing position way too long and then finally bail out of disgust -- often near the bottom of the market. This was sadly the case in February and March of 2009, when many individuals sold out of entire stock portfolios at the market bottom. At the same time, institutional accounts were slowing buying back in and ended up with outstanding returns during 2009.

Here I sound a bit like a broken record, but setting targets is absolutely critical to help curtail these mistakes. If an investor is worried about selling out of a winner too soon or selling out of a loser before recovery, a good policy might be to scale out of investments. For example, if I expect a particular stock in my portfolio to return 10 percent, when that target is reached, I might sell 50 percent of the position. Then, if it goes up another 5 percent, I sell 25 percent more. And so forth.

Steven Dolvin, CFA, Ph.D.

AnswerThere are three common mistakes: starting too late, investing too little and being too conservative. Of the three, starting too late may be the biggest mistake.

Todd Feldman, Ph.D.

AnswerStaying the course is the most difficult thing for an investor. The value of an investor's portfolio will shrink due to financial crises and swing up and down. Investors can become emotional after seeing the value of their portfolios drop significantly, and they'll want to sell. Research has shown individual investors tend to buy and sell at the wrong time. Research on investor psychology suggests investors face a bias called the "recency effect." When prices rise, investors think prices will continue to rise and therefore buy. When prices fall, investors think prices will continue to fall and therefore fall. Therefore, investors tend to buy and sell at a suboptimal time.

The performance penalty individual investors face is around 6 percent. This means investors who let their money sit will outperform individual investors who buy and sell by 6 percent. An individual should choose how much to allocate between stocks, bonds, REITs, commodities, etc., and how much to put away every month and stick to the course. Do not let media, price volatility, your own emotional state or friends drive you from the course. That is the biggest mistake most individual investors make.

 

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