There they go again: Common mistakes investors tend to make
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One of the most asked questions in connection with investing - perhaps second only to “What would be my return?” - is “How much income will I receive?”
I’ve met a lot of investors who require an income from their investment in order to cover their living expenses. For perhaps behavioural reasons, many investors are unwilling to finance consumption out of capital. As a result, many savers are currently looking for high monthly returns in order to earn an income and avoid having to fund living expenses out of their capital.
In an effort to generate sufficient returns from investments, they are taking on too much risk; unknowingly.
"Where do babies come from?"
This was the subject of many debates when I was a kid, and the answer was always the same: "An aeroplane drops them from the sky." Thirty years later, and no one talks about this anymore. Today's kids learn the real answer a lot earlier than I did.
"Where does my monthly investment return come from?"
Fewer people ask this question than the one about babies thirty years ago, and even fewer have the answer. I'll give you one hint: it's not from the sky.
Investors truly make the same mistakes over and over. It may be a new generation of people doing it, and usually, they do it in new markets or with new glamorous financial instruments, but the behaviour is the same.
It rarely happens that the same errors are repeated in successive years. Usually, enough time passes by for the mistakes and cries of the past to be forgotten. If you observe with the benefit of the knowledge of history and objectivity, you can easily see the patterns.
The past three years have been rife with financial innovations that promise to pay people enough money to be rich and earn a massive monthly income (or salary replacement). As I read the website posts in 2017 about the new financial innovations that have high and guaranteed returns as their birthright, I find myself saying one thing over and over again “There they go again”.
Why do people repeat the same mistakes?
First, few investors have been around long enough to see the recurrence of trends that existed in the past. And second, organised crowds have always played a role in the lives of individuals. This is especially true when the good times are rolling. There’s a tendency to ignore the rules of the game when following them leads to uninspiring returns.
Herewith a few common behavioural mistakes:
This is new and different
The most dangerous thing in investing is believing that the rules of the past are old-fashioned and new ways are required to create wealth. It is well documented that when investors take a trend to excess, it eventually goes “pop”!
I will never lose
“Well you never say never and you never say always.” Many investors are still struggling to stop themselves from believing in the most fairy-tale like story of all: an investment without risks. I will say it now: there is no such thing as a risk-free investment or one that guarantees to deliver high returns as its birthright.
The future will look like the past
From time to time, a colourful mix of opportunists (who often don’t understand what they are getting into) and money-driven people convince others that the current environment will continue forever.
Usually, things will get bad at some point and there will be a creation of new market characteristics. Just like in chemistry when certain elements are brought into contact, they combine to form a new body possessing properties quite different from the original.
The storytelling is simple
By this I mean to make fun of investors’ tendency to believe stories that seem true on the surface but ignore how the stock market actually works. These include “I’m about to share with you the biggest secrets of making money in the stock market” and “Make 10.000 euros a month from the stock market”.
Buffett says, “The market, like the Lord, helps those who help themselves…But, unlike the Lord, the market does not forgive those who know not what they do”.
So, in your hunt to generate decent returns, invest in things you understand with a certain level of confidence within your circle of competence.
Past returns will look like future returns
There is no asset class that will do well simply because it exists. An example is property. People say, “You should buy property, it always goes up in value” and “You should buy property, they are not making any more land”.
But nobody tells you that when done at the wrong price and time, property investment doesn’t work. The key is who likes the investment now and who doesn’t. Future prices will be determined by whether more people demand the asset or not.
It sounds too good to be true, but I don’t want to miss out
There have been many times when people knew something was unlikely to work forever but they jumped on the bandwagon anyway. Usually, they do this because they think there’s a bit more left and watching from the sidelines whilst everyone gets rich becomes too painful a pill to swallow.
I’ll get out before it stops working
In the stock market, there is no referee that blows the whistle to prepare you for oncoming danger. Nobody ever asks how they’ll know when to sell before others know, or who they will sell to if everyone is also trying to sell at the same time.
We have secrets that are used by professionals
There are no secrets in the stock market! Warren Buffet, the world’s most successful investor has his every investment success recipe published in every book. Similarly, in the food lab, recipes are as effective as cooking guides; they provide a method from a list of ingredients to a finished dish.
But chefs who rely only on strictly ordered formulas miss what is really important. Do I need to add more or less of an ingredient to satisfy my personal taste? That is because recipes assume a certain basic knowledge, just like a GPS won’t tell you to stop at a red traffic light.
The mistakes listed above express wishful thinking, an inevitable part of human nature. They come from our desire to “hope for the best” and ignore any negatives in our pursuit to make money. When individuals are under extreme financial pressure, as I think many are now, they sometimes behave irrationally. In the stock market, excessive confidence sets the stage for disappointment.
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