I am working on a checklist of the most common errors investors make. I have my own top 10, but I would love to hear other people think are important.

Here is my short list:

1. High Fees Are A Drag on Returns
2. Mutual Fund Are Inferior to ETFs
3. Reaching for Yield is Extremely Dangerous
4. Asset Allocation Decisions matter more than stock selection
5. Passive is usually better than Active Management
6. You must understand “The Long Cycle”
7. Behavioral Issues Are Costly
8. Cognitive Errors as well
9. Understand your own risk tolerance
10. Pay Guys Like Me For the Right Reason

What other factors are — or should be — most important to investors?

Category: Apprenticed Investor, Investing, Rules

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

49 Responses to “Errors and Checklist for Investors”

  1. 1. confusing or not differentiating vol and risk, and thus having no bearing of drawdowns vs expected drawdown
    2. not setting an actionable exit point before entry
    3. refusing to admit their views are influenced by their emotions
    4. using cost (entry price) and P&L to set buy/sell decisions
    5. misunderstanding return metrics (IRR vs linear, et al)
    6. overestimating long term real returns
    7. doing things they don’t understand

  2. peterru says:

    This is an addendum to your #10 — A mistake I have made is to have an adisor that charges fees only on the portion of one’s portfolio that is in equities. This essentially made it my responsibility to actively manage the cash/treasury/equity %’s – esepcially in times where the market conditinos were poor. Better to pay fees on one’s entire portfolio.

  3. calvin_trager says:

    If possible can you briefly expand on the items in the checklist-so we (I) can make sure we are pointed in the right direction. Examples are welcome. Thanks.

  4. blackvegetable says:

    Are you listing the “Common Errors” or the “Rules for Sound Investing”?

  5. nofoulsontheplayground says:

    Ignoring reversion to the mean.

  6. blackvegetable says:

    “Ignoring reversion to the mean.”

    At least not making it determinant………

  7. PeterR says:

    “the most common errors?”

    CHOOSING to be re-born in a human sac of protoplasm, only to be forced to be re-born in another SAC!

    “The Big Picture?”

    Karma.

    Re-birth.

    BIGGER PICTURE?

    Please advise.

    PS — We investors are dust on the review mirror IMO.

    ~~~

    BR: I wish I had a clue WTF you were talking about!

  8. rd says:

    I would question the mutual fund vs ETF. I have seen good inexpensive muttual funds and expensive poor ETFs. If you can get the equivalent fund in an ETF, then it is probably better.

    To make #10 into an error, rather than advice I would make it “Believing an advisor without thorough verification of claims and expenses”

  9. PeterR says:

    PS2 — rear-view mirror.

    Another good QOTD, just in time!

    “To see what is in front of one’s nose requires a constant struggle.” -George Orwell

    Cheers

  10. jake103 says:

    Can we disagree on some of these?

    2. Mutual Fund Are Inferior to ETFs: Too broad a statement. Some mutual funds are great (inexpensive, track indices almost exactly, prevent owners from day trading [see your #7 behavorial issues being costly), while many ETFs are very poor (broad tracking error, expensive, leveraged inverse ETFs)

    3. Reaching for Yield is Extremely Dangerous: Everything is based on appropriate compensation for the risk an investor takes… 5 years ago, an investor sitting in cash received risk-free return. 0% cash is now return-free risk. An investor “reaching for yield” now may actually now be a risk reduction exercise.

    4. Asset Allocation Decisions matter more than stock selection: agree, but by definition asset allocation decisions are “active” decisions, hence….

    5. Passive is usually better than Active Management: seems in conflict with #4

  11. RW says:

    My list is quite similar:

    1. High Fees Are A Drag – yes, w/o a doubt particularly over the longer term, but if time horizon is short it may pay to focus on other variables

    2. Mutual Fund Are Inferior to ETFs – it depends, ETF’s can be as expensive (and poorly run) as a mutual fund and are intermediated products; i.e., dealing directly with a large mutual fund house like Vanguard puts you a step closer than a stock broker can get you

    3. Reaching for Yield is Extremely Dangerous – reaching for yield can become dangerous when product diversification is low but mixing bond duration and quality w/ mlps, bdcs, convertables, etc all in due proportion can reduce risk significantly

    4. Asset Allocation Decisions matter more than stock selection – both research and experience appear to confirm this although I would miss my occasional 10-bagger and so continue to speculate albeit in a separate, sequestered portfolio (keeps itchy fingers out of core portfolios w/ same iron clad rules I use in poker: if you lose your initial stake you have to leave the table, no exceptions)

    5. Passive is usually better than Active Management – if “passive” means a minimum of fiddling once an allocation decision is made then, yes, but see 4

    6. You must understand “The Long Cycle” – yes, secular environments alter business cycle articulation w/o a doubt; asset allocation decisions require knowledge of both

    7. Behavioral Issues Are Costly – oh mama mia, yes!

    8. Cognitive Errors as well – damn straight

    9. Understand your own risk tolerance – yes but also understand how little you know and why you may not realize how much risk you are actually taking on; corollary, take the time to learn the investment vehicle cold and …

    10. Pay Guys Like Me For the Right Reason – don’t do that much these days but see 9

  12. Sunny129 says:

    - Recognize that power of perception can be stronger than the reality/fundamentals, at times ( the irrationality of market can last longer than you being solvent!)

    - Recognize that there secondary trends within and against the primary trends – bear trap rally in secular Bear market.

    -There is more to ‘asset allocation’ concept including strategic and tactical allocation in response to changing market conditions and valuation of particular assets.

    - Never confuse trading vs investing although one should know when and how they work and under what circumstances.

    -Mr. Market NEVER accommodates the majority!

    -Once Govt favors one industry over another, free market capitalism ceases to exist and crony capitalism reigns!

  13. CANDollar says:

    Not enough attention is paid to taxes so “Use tax advantaged accounts efficiently”

    A few more (from Ron Dembo):

    Use scenarios not forecasts
    Know what you own
    Anticipate regret

    In a potentially low return world any change that can lower portfolio carry costs can be more useful.

  14. Needing a certain return to meet your goals doesn’t mean there is a sane way to get it.

  15. Conan says:

    I think it is more fundimental….There are many ways to make money…Are you a value investory, momentum trader..or what approach or combination of approaches will you use…do use charts or fundamentals, do you invest in individual stocks or indexs or funds…what types of assests will you use Equities, bonds, currencies, commodities….bottom line what is the way that you should invest needs to be deiced first….If you don’t know yourself…how you plan to invest and have a tested plan…it is all a waste of time and money…

    You better read, get advice do simulations and start low in placing your money….it will take time to learn….If you can’t do this then you need to vet a good advisor to invest your money for you….money is too hard to get to just willy nilly go about this…investing is hard and is serious business…

  16. VennData says:

    Taylor Larimore’s Investment Gems from ‘Investment Mistakes Even Smart Investor’s Make’ by Swedroe and Balaban

    http://www.bogleheads.org/forum/viewtopic.php?f=10&t=86277

  17. A says:

    Barry, I think you covered this in the ‘passive’ point, but good to always emphasize:

    Investments are like a bar of soap: the more you touch them, the smaller they get.

  18. California23 says:

    Overtrading. Many investors have a good portfolio and sell at the right time. You may have that captured under behavioral factors (i.e. loss aversion) but if not I would include.

  19. I disagree on the mutual fund vs ETF point……MUCH too broad. Also, one of the “benefits” of ETFs…daily liquidity can actually be their downfall….How important is “liquidity” if it means you can dramatically give up on the more important aspect which is “price”. Liquidity disappears when it is needed most.

  20. I meant intra-day liquidity….

  21. howardoark says:

    Fighting the Fed has not been profitable for me the past couple of years.

    Being unwilling to cut losses – there was an excellent post here this month pointing out that the typical investor is only happy when their stocks are down because then they don’t have to think (Can’t sell because if the stock went back up, they’d have been wrong twice).

    Not knowing where you’re going – if you need a 30% annual return to retire in 10 years and you’re 60 years old, you shouldn’t be in Walmart, if you need a 3% return in 10 years and you’re 50, you shouldn’t be in Bolivian tin futures. The corollary is that you shouldn’t get into a position where you need 10 years of 30% returns to retire at an .

    Believing your brother-in-law when he tells you he’s had a 25% annual return for 10 years and boy does he have a hot stock for you.

    Believing in Technical Analysis to the point where you don’t even know what you’re investing in but you’re convinced you would be rich if only you were a little bit better at TA. Ignoring TA is also a mistake.

  22. i. You must understand “The Credit Cycle”
    ii. Some stocks are buy and hold. Others are buy and sell. Know the difference
    iii. Manage risks before managing returns
    iv. Be objective. The minute you ‘fall in love’ with a position is the minute you should watch RomComs (romantic comedies), not invest
    v. Be contrarian and right, not consensus and wrong (or even consensus and right)

  23. Larry says:

    Item 6- Understand the long cycle. By this do you mean to consider that there are long-term secular bear and bull markets? And perhaps to understand where we might be now in terms of a long-term cycle? That can be very difficult and can be an issue that many good investors will disagree on.

    Or, did you mean to say: don’t focus on the short-term. Keep a longer term perspective when building your portfolio. ?

  24. xcvgfudsia says:

    Item 6- Understand the long cycle. By this do you mean to consider that there are long-term secular bear and bull markets? And perhaps to understand where we might be now in terms of a long-term cycle? That can be very difficult and can be an issue that many good investors will disagree on.

    Or, did you mean to say: don’t focus on the short-term. Keep a longer term perspective when building your portfolio. ?

  25. Pantmaker says:

    1. Investment checklists aren’t particularly useful.
    2. Sell your winners.
    3. Shorting is not the boogeyman.
    4. Mean reversion is very real.
    5. Long term return projections are generally too high.
    6. Cash is a legitimate asset class. People who tell you otherwise want your money.
    7. Keep things painfully simple.

  26. caerick says:

    Barry, #7 (Behavorial Issues) should be listed as #1 as it is has more impact than the other 9 reasons combined. Just look at the Dalbar data over the last few decades which shows an enormous gap between mutual fund investors’ actual dollar weighted returns vs. mutual funds’ time weighted returns.

  27. katland says:

    The more complex the investment instrument is, the higher the chance you are getting screwed.

  28. constantnormal says:

    katland — I like it, but I would extend it beyond the mere instrument … how about this:

    The more complex the investment strategy is, the higher the chance you are getting screwed.

  29. ElSid says:

    I am convinced that most non-savy retail investors should buy a house, buy another house to rent out, or start a business with the money instead. Then they would be in something they could understand, and the prices of it wouldn’t be posted on the internet every minute of the day, so that would eliminate a couple of those issues on that list.

    “3. Reaching for Yield is Extremely Dangerous” is a very modern problem that will probably change about as soon as you add it to the canon of advice. Now that that’s all that’s offered, everywhere, it almost certainly won’t last that long. The whole world can’t be Japan.

    As for “9. Understand your own risk tolerance”: if the markets are efficient and someone can allocate based on your age, as is alleged, then if your “risk tolerance” calls for bonds when your age calls for 47% stocks, you may end up eating dog food in your old age, right? I mean, how does some financial advisor say “You have to allocate your funds this way because of much high mathematics” and at the same time say “but if you want to chicken out, that’s okay, too”? It’s an apparent contradiction that could never understand.

  30. SamAntar says:

    (1) Unexamined acceptance: Don’t take management’s or any Wall Street research analyst’s word for anything. Critically examine their representations and comments.

    (2) Never assume that audits will find fraud or material accounting errors.

    (3) Always study the footnotes and other disclosures before you look at the financial reports (income statement, balance sheet, and statement of cash flows). Look for subtle changes and inconsistent disclosures. Compare the footnotes in the current period with footnotes from previous periods.

    (4) Cross-check management comments made in earnings conference calls with comments made in previous earnings conference calls and comments made in other venues such as the press.
    (5) Never ignore corporate governance issues.

    (6) Pay attention to the opinions of short sellers. You don’t have to agree with them, but you should take into account their concerns.

    (7) Look for red flags such as: inventory growing faster than revenues, declining inventory turns despite revenue growth that exceeds management’s guidance, accounts receivable growing faster than revenues.

    (8) Don’t buy a stock just because any institution is heavily invested in it. I screwed top institutional investors at Crazy Eddie. Most institutional investors are not very smart, fail to perform adequate due diligence, and ignore red flags.

    (9) Never fall in love with any company. They are not a sports team. You should be a critical investor and not act as if you are a sports fan.

    (10) If you don’t follow the advice above, stick with index funds.

  31. dsimmons says:

    I think mine is addressed in #10 “Pay guys like me for the right reason”, but I’ll throw mine out there.

    Investment managers are advisers, not prognosticators.

  32. ConscienceofaConservative says:

    Mutual Funds and ETF’s are vehicles not investments. The superior vehicle is the one that delivers lower costs.

  33. Tom says:

    All good feedback, Barry, but any attempt to list a “top ten” without mentioning proper tax planning would be incomplete. Taxes are typically any investor’s largest lifetime expense and too few advisors are sensitive to proper tax planning in their practice. It is not just asset allocation, but asset LOCATION.

    Thanks for all you do!

  34. dead hobo says:

    Believe what you see, not what you are told. Make assumptions about everything, then learn from your mistakes. Continue refining this process and you will see most experts as nothing but salesmen. The rest will probably be true believers.

    Everyone has something of value to say. Everyone also talks crap. Being able to recognize both is valuable. Even crap can work as a fertilizer.

    Just because 50 billion flies eat shit does not mean it is good food.

  35. gibbswtr says:

    1. Know thyself
    2. You will be lied to daily by Wall Street it is your responsiblity to sort out the lies from the truth
    3. Chasing perfromance is a fools game
    4. Day trading is a double fool’s game
    5. Better to be out wishing you were in that in wishing you were out.

  36. carleric says:

    Admit when you are wrong and take action to get out…..there are all kinds of rationales for holding a bad investment and all of them are bad. We all get it wrong often….if you are right 60% of the time you are exceptional.

  37. Livermore Shimervore says:

    1-How do the 10 best performing mutual funds year to date compare vs. the 10 best performing ETFs?

    2- YTD, What % of mutual funds outperform the DOW and NASDAQ 100?
    What % of sector ETFs outpeform the DOW and NASDAQ 100?

  38. swp78 says:

    the biggest issues i have to improve on (of many)

    1. determine whether it is investment vs trade (don’t confuse one for the other, or worse, switch)
    2. separate the real datapoints of substance from the noise,
    3. be a ‘devil’s advocate’, be contrarian, and understand why the shorts are short
    4. know when to sell (related to #1)
    5. any of a host of behavioral issues

  39. [...] Ten errors investors make: a growing list.  (Big Picture) [...]

  40. jmtxmountie159 says:

    Haven’t I been reading this same list in John Bogle’s writing over the last 25 years? BTW I follow it, and it works for me.

  41. DarthBeta says:

    Don’t lose money- recognize capital is a tool
    10% down and 10% up do not make you even
    Dollar cost average can be determental
    Outperformance against a benchmark does not = making money
    The goal is more capital not performance

  42. cognos says:

    Why high fees?

    Who charges the highest fees? (hedge funds. many are simply outstanding.)

    Renaissance Tech – 5% mgt fee, 40% of performance. Approx record (net of all fees) = 30 yrs, zero down years, 35% ann return. SERIOUSLY.

    SAC Capital – 3% mgmt fee, 50% of performance. Approx record (net of all fees) = 20yrs, 1 down year, 28% ann return. Seriously.

    See also: Soros, ESL, Viking, Millennium, etc.

    Bad investors will always select bad investments. Its not about the fees. Its the wrong thought process, gamesmanship, etc.

    ~~~

    BR: Its easy to look back at a 20 or 30 year track record and say “Hey, this is good.” Its much harder to make that call BEFORE they have a multi-decade track record. (And of course, you and your measly 5 million dollars cannot get into any of these funds anyway). You are citing the top 0.01% of funds. They are not typical.

    BTW, what hedge funds should you buy over the next 20 years?

  43. cognos says:

    Some very low fee investment firms include:

    BGI, AllianceBernstein, LeggMason, index Equity funds.

    These all seem to SUCK… but charge 20-200bps annually. Low fees doesn’t seem to help performance.

    ~~~

    BR: You have it backwards — low fees may or may not help performance, but high fees DEFINITELY hurts performance.

  44. cognos says:

    For me… Your #6-10 are actually a WAY better #1-5.

    Might also include: 1) Common Sense; 2) Business Cycle; 3) Data Driven Decision Making; 4) Know your strengths and weakness; 5) Constant innovation, research and hard work.

    Slightly more obscure, intellectual…
    6) History doesn’t repeat, it rhymes.
    7) Dual-reflexivity (see Soros… are you a sheep?)
    8) Can you deeply understand the way things work. (See Dalio, Buffett, Gross)

    All the stuff on “Fees” and “Mutual Funds” could be re-stated – “Are you a sheep?”

  45. [...] this week, I mentioned a short list of common errors many investors make, and cobbled together a top 10. Readers had a number of very astute and specific [...]

  46. end game says:

    Taxes, taxes, taxes. Studies show that 10% turnover does as much tax damage as 100% over time. Partially covered in points 2 and 5, but it needs to be pointed out that assiduous, year-long tax loss harvesting is critical as well, adding as much as 1 to 2 percentage points a year to after-tax returns.

  47. [...] Ten errors investors make: a growing list.  (Big Picture) [...]

  48. end game says:

    Peterru: Or you could find a broker who just charges you a fee for equities and still assumes responsibility for your overall risk allocation because it’s the right thing to do in return for managing all of your assets. See Barry’s point number 1 above. Why should your broker earn a fee for managing risk-free Treasurys? The incentive is keeping you as a client, and the verification is performance measurement, something our industry does poorly, but some do well.

    PeterR: We all wish we knew WTF you were talking about, although the Orwell quote was good.

    Barry Ritholtz: Your list is excellent and education about it is badly needed in our industry. I would weigh in on the mutual fund vs ETF questtion by asserting that you are right, assuming you mean low cost beta, not “active” ETFs, and also that there is strong support for a core/satellite split between passive ETFs and active mutual funds that varies the % allocated to the core based on the probability that active managers will underperform the index; e.g., 80% passive 20% active if 20% of active managers outperform.

    RW: MLPs, BDCs and converts will all come crashing down in a crisis. Treasurys will probably rise. Hence reaching for yield is extremely dangerous. There will be no diversification benefit as you imply because they will all correlate to stocks in a meltdown.

  49. [...] E. Hultstrom of Financial Architects submitted this list in response to our Checklist of Errors, and its a good [...]