Two easy ways to lose big in 2013
Reprinted courtesy of MarketWatch.com
Published: Feb. 27, 2013
To read the original article click here
The stock market has been kind to investors lately, and despite the failures of our government, optimism is stronger than pessimism. Here’s a warning to investors: Look out!
Despite the generally cheerful tone in the media and on Wall Street, thousands of investors will lose their shirts this year. Some of them will set their retirement dreams back by years. Some will conclude that they will never be able to retire. Will you be among them?
There are lots of ways this could happen, but today I’m going to focus on two. I hope you are fortunate enough to avoid these two traps. At the same time, I can just about guarantee that somebody you know will be caught.
Perhaps the most common way investors get into deep trouble is by trying to beat the market. The cruel truth is that such attempts rarely succeed except by accident (which is another way of saying luck). And yet the very attempt to beat the market turns would-be winners into real-life losers.
In my 2011 book, Financial Fitness Forever, I devoted a whole chapter to the perils of beating the market. Here are five:
- When you try to beat the market, you’re bound to focus on performance, especially short-term performance. You’re in a race to win, and (just like any good sports fan) you want to know the score, and you want to know it now. What you want emotionally is a good score now; but what you really need as a long-term investor is a good score some decades from now. What sports fan has that kind of patience?
- When you focus on performance, you are likely to ignore the most powerful factors that build favorable long-term results: Expense control, tax efficiency, diversification and risk control (to name only four).
- When you’re hellbent on beating the market, you are likely to latch onto dreams of “a new era” that supposedly will bring wealth to people who get in on the ground floor. Remember the dot-com investment boom of the late 1990s? Successful investing almost never depends on new-era fantasies.
- Logically, beating the market is a terrible goal. If you make 20% in a year in which the Standard & Poor’s 500 Index goes up 30%, you have to consider yourself a failure. If you lose “only” 40% of your retirement nest egg in a year when the index loses 50%, you have to be willing to congratulate yourself for successfully beating the market. (Will your spouse or partner see it that way?)
- Your quest to beat the market is likely to lead to emotion-based buying and selling decisions. You’ll follow the herd, buying high and selling low, exactly the opposite of what successful investors should do.
And what’s so bad about following the crowd? The majority of mutual funds fail to beat the market. And, as the well-publicized DALBAR study has shown for many years, individual investors as a whole fail to achieve the returns of the funds in which they invest, because of misguided buying and selling decisions.
Don’t be a pawn
Finally, trying to beat the market makes you a pawn of Wall Street. That leads me to my second point.
In the next 10 months, lots of investors will lose lots of money because they have bad financial advisers or follow false gurus. The investment industry always has something up its sleeve to entice investors and separate them from their money. It may be initial stock offerings. It may be gold or some other commodity. It may be a high-paying “safe” substitute for bonds.
Despite the hope and hype, in the sales-driven culture of Wall Street, “the house” always wins, and the investor sometimes wins. This is summed up in a familiar adage: “The broker makes money, the firm makes money and the client…well, two out of three isn’t bad!“
Wall Street doesn’t like average, even though average results would be an improvement for millions of investors. Brokers know every trick in the book to persuade investors to be dissatisfied, to succumb to fear and greed.
Whatever you have invested in, no matter how well planned, almost every broker and manager has a better idea. These better ideas almost always involve beating the market, beating the odds, and producing short-term emotional rewards. In this way, Wall Street makes money by turning investors into speculators.
Naive investors are likely to take the bait. Savvy investors understand that “a good idea” is almost entirely unrelated to a solid long-term plan.
If your goal for 2013 is to lose money, I’ve just shown you two easy ways to do so.
But if your goal for 2013 is to hang onto your money and make it grow, take a few minutes to refresh your memory on the most important things every investor should know. I’ve summarized them in a podcast that you will find here.
Richard Buck contributed to this report.
Purchase on Amazon
Sound Investing Podcast