Peter Mallouk's book should be required reading for anyone going near any market. Here are the five common mistakes he dwells upon.Market Timing
People often tell me: “I have cash on the side, and I’m waiting for things to get better” or “I’ll invest my money after (insert any excuse).” Unfortunately, market timing doesn’t work; the evidence against it is overwhelming. Academic research shows it, economists miss it, media gets it incorrect, investment managers get it wrong. As long as you believe in capitalism, every bear market will give way to a bull market. No one can predict the timing of these moments, and you will do more harm than good by trying to navigate your way through them by trading.
Paying for Active Management
There are thousands of mutual funds and hedge funds that trade U.S. stocks. Additionally, there are actively managed exchange-traded funds (ETFs), many separately managed accounts, and all the individuals who trade U.S. stocks on their own. Combined, this group is trading within the same basket of ~4,000 stocks. But trading isn’t free: there is a house who gets paid no matter who the winner is. We know that an investor will pay more in fees with active trading/management; we know that the investor will pay more in taxes; we know that active management will underperform in most cases. Don’t fall into the trap of trying to beat the market or game the system. The only person being gamed is you!
Misunderstanding Performance and Financial Information
“Past performance is not indicative of future results.” This warning is found in almost every financial marketing piece ever created. Performance can’t be judged in a vacuum; reference sets are critical. If someone is winning at the roulette table, we know this one gambler is the outlier in the larger set of losing gamblers within the casino. Investors often give the hot-handed gambler their money – investing in the fund manager who has recently outperformed. When evaluating a manager, ask to see the performance for all of their strategies. When you look at the full reference set, the success of one strategy will appear for what it is: the expected outcome when viewed as just one of many.
Letting Yourself Get in the Way
The more you know, the better informed you are, and the less likely you’ll make a mistake – right? Wrong. Fear and greed are two of a human’s most powerful forces. Amateur investors fall prey to them, legendary investors recognize and know how to control them, and everyone else feeds into them. Worse, humans are evolutionarily hardwired to move in herds. Ultimately it is our own behavior that does us in. Shut out all the noise and stick to a disciplined investment strategy.
Working with the Wrong Advisor
Working with a fiduciary-only advisor removes all conflicts of interest as he/she always sits on your side of the table. Also, working with an advisor who uses an independent custodian ensures you get impartial reporting (think Bernie Madoff’s Ponzi scheme). I know of no other industry where people go for professional help and often end up worse than where they started. Selecting the right advisor can greatly increase the odds of reaching your financial goals while providing peace of mind.