Avoid Making This Key Investment Mistake
Most articles give you tips on how you should invest. They may describe techniques of finding undervalued companies or encourage you to invest in stocks that you may know best. As for mutual funds and ETFs, they may encourage you to find ones with low fees and good management.
This is all well and good, but often, people’s mistakes in the market do not come out of failing to look for these goals. Often, people make bad investment mistakes for entirely other reasons. Most of the time, it is because these people get greedy and fearful and follow the herd. They avoid buying stocks that appear undervalued and instead buy stocks that are grossly overvalued because those stocks have been hot lately.
People’s cavemen instincts lead them to do what their friends and others are doing. It feels natural. Also, when things are looking horrible, they want to sell. Likewise, when stocks are running up and up, like they did in the late 20’s or like tech stocks did in the late 90’s, they want part of the action. This leads to people buying high and selling low.
While I’ve preached a lot about avoiding buying high and selling low in the past, it often falls on deaf ears. Many times, people don’t even realize they are following the crowd, when in fact, that is exactly what they are doing. Here are some tips to tell if you are making decisions that follow herd logic:
You make an investment because a lot of your friends are making a similar investment. While sometimes your friendship group may be onto something, often it is a sign that you all are following the herd and are buying late.
You react to how major newspapers categorize the market or the economy. By the time mainstream America thinks something is going to happen, it has long been priced into the market. For example, take the ‘recession’ that America supposedly went into the first quarter of 2008. By mid-March, when it was all over the news, the market had hit bottom. If you had sold out then, you would have missed out on an almost 8% up move in the market.
3. Buying an asset class you are unfamiliar with. Many people got into real estate in 2005 and 2006 because of the amazing returns they heard other people got from flipping houses. These people were unfamiliar with the asset class, but got into it because other people were doing it. Now, in my opinion, many people are doing this with commodities, including energy ETFs. In the late 90’s, many people were buying tech stocks even though they had no idea what the company really did or how it would ever be profitable.