Seven Ways You Might Actually Be A Really Bad Investor
It’s easy to feel like a good investor in the midst of a bull market. Pick nearly any investment you like and as long as there isn’t something terribly wrong with it, the stock will probably go up.
For most investors, it’s easy to feel like a genius when all the facts point toward you having “the midas touch” when it comes to stock investing. Like the myth of King Midas, everything he touched turns to gold but this eventually became a curse.
Let’s get real here — The bull market has now lasted nearly 9 years, one of the longest in recent history. Frankly we’ve all been really lucky to have such great market conditions. Most investors are probably in need of a good dose of humility to get our heads out of
our asses the clouds.
This year alone the S&P 500 is up 5.1% as I write this, and my own portfolio is up about 8.5%. It’s easy to feel smart… and that’s dangerous.
Personally, I’m a big believer in humility. There’s far too many arrogant people in the world who believe they’re something special. I have no desire to be one of them.
So, today’s post is all about reminding myself (and you) to stay humble — This market could be extremely overvalued, and stocks could in-fact be entering a long period of stagnation. One that could last for a decade.
Despite bull market performance telling me I’m doing great, I could in-fact be a really bad investor.
In the spirit of humility, today’s post is a slap across the face and a bucket of cold water on those stock market daydreams. Sober up investors! I give you 7 Ways You Might Actually Be A Really Bad Investor…
1. You’re Trying To Predict The Future
Most investors buy a stock or invest in a ETF with the expectation that it’s going to go up. This in itself is a prediction of the future. Maybe you believe that Amazon is going to kill all brick and mortar retailing, or perhaps you think Tesla is going to destroy the market for gas-powered vehicles in 5 years. Whatever the case, this is a prediction of the future.
If there’s one thing people often get wrong, over and over again, it’s predictions of the future. Humans are notoriously bad at it.
I hope your crystal ball is better than mine, because I’m still waiting for my flying car!
2. Chasing Yield Is Going To End In Tears
Dividend investors love to pick stocks with high dividend yields to get that sweet-sweet income. Dividend income is one of the ways I was able to reach financial independence, and it seems like easy money when the economy is really good. High yielding stocks can generate A LOT of income.
But there is such a thing as too much of a good thing.
Frequently the companies with the highest dividend yields also have the highest payout ratios and the worst financial positions. When a recession finally hits, these high yield companies are the most likely to run into trouble and the first to cut dividends.
And that’s a recipe for underperformance. Don’t say I didn’t warn you when you’re crying your eyes out after that massive dividend cut.
3. You Might Be Paying Way Too Much For Growth
Growth stocks always sell at a premium compared to stagnant companies or those on the decline (*cough* GE *cough*). The higher the growth rate, the higher the premium the investor pays.
The thing is, growth investing is like a game of musical chairs — most of us have no idea how big that growth stock is going to get, and when the growth music finally stops… disaster happens.
Facebook’s recent performance (or should I say underperformance?) is a perfect example of what happens when investors realize they’ve been paying too large a growth premium.
It’s often the case that the higher the price you pay, the lower your long-term returns. That growth premium could actually be hurting your returns.
4. Buying Bonds Could Be A Bad Idea
So the stock market is at all time highs — If you’re the kind of investor that wants to take advantage of the market’s natural cycles, you might then be thinking about selling stocks and moving money into bonds.
Nothing wrong with locking in some profits, right?
On the surface this sounds like a good idea (bond’s are supposedly safer than stocks), but this could ultimately be a bad idea. Why?
You see, bond prices move inversely to interest rate moves. When interest rates fall, bond prices rise. When interest rates rise, bond prices fall.
And the Fed plans to keep raising rates this year.
That said, bond investors do have a couple things going for them — First, the interest received on those bonds could offset any losses from falling bond prices. (In this case, wouldn’t it make sense to just hold cash instead?)
Second, if the investor purchased the bond at or below par value, the price swings mean very little if the bond is held to maturity. In the short term the price may fluctuate wildly in response to interest rates, but over the long term the bond will be redeemed at par (returning the investor’s original investment).
So be wary as a bond investor! Patience and good purchase prices are important — without these qualities inflation and rate raises can destroy expected returns.
5. Do You Have The Investor Disease?
Do you have the investor disease? I like to call it short-term-itis. If you find yourself buying and selling a stock in a span less than five years, you probably have short-term-itis. The temptation to take advantage of “short term” gains or losses can be a big one, especially for investors with deep knowledge of a particular industry.
Short term trading means higher trading fees, and usually lower performance. History has shown that really good stock returns come from holding stocks over very long periods of time.
That attempt to lock-in gains or avoid losses could ultimately be harming your returns instead of helping — You might be selling far too soon and missing out better long-term performance.
6. Share Buybacks Might Be Fool’s Gold.
When companies announce big share buybacks, investors cheer the news and the shares usually rise, right?
On the surface this might sound like great news, but many Fortune 500 companies also issue new shares on a regular basis to award employees and executives. Those share issuances can sometimes be so great that the number of shares outstanding actually grows in a given year (despite the share buyback).
Really good stocks have a habit of keeping share/option awards under control and buying back shares regularly to reduce the outstanding share count.
7. Global Diversification Might Just Be A Waste Of Money
Do you stache most of your cash in index funds and then find yourself investing in something much more unusual to get a little “Global Diversification”? Well, you might be wasting your money.
Instead of paying 0.1% in fees for a basic index fund, at minimum you’ll be paying fees twice as large (or higher) to own a “Global” fund. That’s a high price to pay just to own a few stocks listed on non-U.S. stock exchanges.
What if you only owned the S&P 500 index? How much global diversification would you have? The largest firms in the S&P 500 index are already major global companies. In fact, the companies in the S&P derived 45% of their sales internationally and 55% domestically.
That’s a considerable amount of global diversification without paying for the high fees of a “international” fund. You’ll end-up owning many of the same stocks too!
While you could actually be one of the world’s best investors, most of us won’t turn out to be more than average (by definition).
Don’t convince yourself that you’re a special snowflake. The good performance we’re seeing today could simply be luck. Don’t let it go to your head. Hubris is a terrible trick played on investors by powerful bull markets. This leads to arrogance and overconfidence in our abilities.
Never have I heard those qualities listed as requirements for being a really good investor. Patience, humility, intelligence, and caution are qualities that will serve you well instead.
So today I’m going to leave you with the same advice I’m giving myself when the bull market keeps raging ahead — Stay Humble. This too will pass.
Eventually the bull market will transform into a bear market and many of the “smart investing moves” we’re making today could turn into small financial disasters.
Good luck out there!
[Image Credit: Stock Market Bull]
22 thoughts on “Seven Ways You Might Actually Be A Really Bad Investor”
Ouch, couple well made points here. Have made several mistakes already out of the 7, then again, think I’m now (finally) fairly well positioned for the future (whatever that might hold). Don’t plan to change much unless there are serious issues with the companies I own that I did not see. Time will tell….
Nice post Mr Tako!
Thanks Cheesy! Mistakes are how we learn — so stay positive!
I have learnt a lot from the fire community over the past few years, especially on the expense side of things. But in my opinion there is too great an emphasis on net worth, which is hugely volatile for a stock portfolio. We will be tested in the next bear market, as you continually warn. The emphasis should be on future long term earnings, not stock prices, as stocks follow earnings over lengthy periods.
Your 7 rules reminds me of the following Buffett quote, “ In the end, what counts in investing is what you pay for a business…and what that business earns in the succeeding decade or two.”
Thanks for the article Mr Tako, inversion in true Munger fashion.
Thanks Fury! I completely agree that most investors only care about stock prices instead of focusing on the business earnings like they should. Index funds only make this phenomenon worse!
Prices will fluctuate!
I’m humble, but I’m still not sure what to do. I figure bond funds will drop, but it won’t be that much. We have plenty invested in international funds too. The fees are higher and they rarely outperform the S&P 500… There are a lot of uncertainties over the next few years. Good luck to us all.
Want to know what to do? Keep turning over rocks. *Investing* rocks that is.
Some days you’ll find some really interesting stuff.
I made some of these mistake years ago. An I found out I was a bad investor. A really bad one.
Then I just used index funds and made it to FI. Thank goodness there’s another way!
Absolutely. There’s multiple ways to cook that fish, but be careful what prices you pay — even for index funds.
Great reminder – thank you. I read that as of August 22nd this will be the longest bull market of all time. Wild times (if we make it). Also I’m totally with you on bonds and global funds.
Thanks APL! 🙂
Great points as always. I think there is a new generation of investors like you mentioned that have only been part of a bull run and think they are the next Warren Buffet. Will be interesting how investors behave when the markets turn down for the first time in almost a decade.
I too worry about heavily relying on dividends as well because you never know when dividends may be cut and if that is your only source of fixed income you might not be able to adapt. This is the reason I have been trying to get more of my passive income through real estate ventures (private syndication). Feel this is a bit more reliable.
Some people I know have done really well with real estate, but it seems to depend entirely upon where you live. Some parts of the country it’s just gambling instead of investing.
Know the difference between the two.
Haha, I have no doubt that I’m a bad investor! 😉 So I try to keep things simple now and have shifted almost everything to total stock market index funds. I think a lot of the Jim Collins’ Stock Series was kind of an eye opener for me. Is everything he says right? Couldn’t tell you, but it just made a lot of sense to me.
The bonds side is a little bit of a struggle for me because of exactly what you’re saying about the possibility of prices falling. So right now, a lot of my allocation outside of the market is in cash. I’m counting on that to be my stability in the case of the market crashing when I leave my job at the end of the year. This FIRE stuff’s a little scary, ya know?! 😉
Since you’re kind of retiring “at the top” Jim, I think your biggest worry should be sequence of return risk.
The odds of you hitting another 9 years of positive returns seems fairly unlikely. Granted, your expenses should be pretty low in Panama.
Hi, I really enjoy reading your blog. With the little free time I have, I always make time to read your posts.
I am a terrible investor. I am all over the place and now my portfolio has way too many stocks/ETFs for me to keep track of. Luckily, I do most of my investing with Merrill Lynch so most of my trades are free. I am working hard to build up my dividend portfolio to financial freedom so I do fall into the high yield chasing trap.
Yeah, don’t chase high yields… especially near the market top!
The same has been going on in the real estate market. There are so many newbies who have made some huge returns in this last cycle but now quite a few people are investing on future gains. Not going to be pretty when the downturn does finally happen.
Well, this is how a whole new generation of investors are going to learn a good lesson. I hope they learn it well.
The value of bonds going down during a rising interest rate environment is true, however, you also have to look at bond duration. Is it a short-term or long-term bond? 100% equity during a market crash will be very painful. The fixed income from bonds and dividend producing assets will be helpful–especially if you’re retired and living off that income. That being said, only chasing yield and being subjected to sector risk doesn’t make sense either. We can’t predict the future so it makes sense to have backup plans for everything. Staying humble and staying the course is the key.
It’s true that bond duration effects the price swings. Longer term bonds swing in response to interest rates the most (generally) and shorter-term bonds swing a little less. Another example of where chasing yield can hurt.
Most bond funds own a mix of short and long term bonds, but they certainly won’t be isolated from the swings. For example, Vanguard’s Total Bond Market Index fund is down nearly 1% over the last year and has a average duration of 6.1 years. That’s not a very long duration but the effect is still noticeable in its poor performance.
I appreciate your constant nudging to anticipate imminent less than stellar market returns and stay real. Will be interesting how many of us living on savings eventually go back to work out of necessity or fear.
Regarding bonds, having my tax advantaged bond index fund discounted when rates rise is a bummer, but having the price rise while returning less income isn’t all that great either. I’m not particularly stock/ bond savvy at all, but it seems the function of bond funds to someone who periodically rebalances per simpleton investing guidelines (like I do) is rate direction neutral over the long term.
Speaking as someone from Australia, our stock market is somewhere around 3% of the global market, so for us – you’re a bit reckless NOT to have a toe in the water with International shares/stocks!