5 Mistakes Every Investor Makes and How to Avoid Them

PETER MALLOUK is President and Chief Investment Officer of Creating Planning and its affiliated companies. Peter's companies provide comprehensive wealth management services to their clients, including investment management, financial planning, charitable planning, retirement plan consulting, and tax and estate planning services.

• Preface xiiiAcknowledgments xvAbout the Author xviiLegal Disclosure xixIntroduction The Market Wants to Be Your Friend xxiMistake #1 Market Timing 1The Idiots 5Why Is It So Hard to Beat the Market? 6Efficient Markets 7The Evidence (Research and Stuff) 8The Media Get It Wrong, Over and Over Again 8Economists Get It Wrong, Over and Over Again 9Investment Managers Get It Wrong, Over and Over Again 14Newsletters Get It Wrong, Over and Over Again 17Your Buddy 18Strategies That Don't Sound Like Market Timing but Are Market Timing—Oh, and They Don't Work Either 19Asset-Class Rotation 19Tactical Asset Allocation 20Style Rotation 20Sector Rotation 20What Smart Investors Have to Say on Market Timing 20Knowing All This, Why Would Anyone Market Time? 21Corrections 22Bear Markets: An Overview 26Bear Markets Happen for Different Reasons, but the Outcome Is Always the Same 27Bear Markets Are Not Predictable 28When Bear Markets "Turn," They Make People on the Sidelines Look Silly 30The Market Is Volatile—Get Used to It 30You Can't Wait for Consumers to Feel Good 31Learning to Accept the Bear Markets 33Miscalculating the Risk of Market Timing 34But What If I Am Perfect? 34Lump-Sum Investing versus Dollar-Cost Averaging 36Learning to Fly 40Avoiding Mistake #1—Market Timing 41Mistake #2 Active Trading 43The History of Active Trading 44Active Investment Managers Lose to Indexing 45Newsletters Lose to Indexing 45Active Mutual Funds Lose to Indexing 45Survivor Bias (a.k.a. Mutual Fund Performance Is Even Worse Than the Data Suggests) 47What About the Winners, Huh? What About the Winners?! 48Hedge Funds Lose to Indexing 51Endowments—Misperception of Performance 56Venture Capital (Sounds Sexy but Usually a Dog) 57The Taxman Cometh (a.k.a. Dear Goodness, It Gets Worse) 59Portfolio Activity Hurts Performance 59But Doesn't Active ManagementWork in a Down Market? 60Why Indexes Win 61But Indexing Results in Average Returns 62S&P 500, Here I Come! 62Avoiding Mistake #2—Active Trading 64Mistake #3 Misunderstanding Performance and Financial Information 65Misunderstanding #1—Judging Performance in a Vacuum 65Misunderstanding #2—Believing the Financial Media Exists to Help You Make Smart Decisions (a.k.a. the Media Is Killing You) 67Misunderstanding #3—Believing That the Market Cares About Today 71Misunderstanding #4—Believing an All-Time High Means the Market is Due for a Pullback 74Misunderstanding #5—Believing Correlation Equals Causation 77October Is The Worst Month to Invest 77Sell in May and Go Away 78Misunderstanding #6—Believing Financial News Is Actionable 79Misunderstanding #7—Believing Republicans Are Better for the Market Than Democrats 80Misunderstanding #8—Overestimating the Impact of a Manager 82Misunderstanding #9—Believing Market Drops Are the Time to Get Defensive 83Avoiding Mistake #3—Misunderstanding Performance and Financial Information 84Mistake #4 Letting Yourself Get in the Way 85Fear, Greed, and Herding 85The Overconfidence Effect 89Confirmation Bias 93Anchoring 95Loss Aversion 97Mental Accounting 98Recency Bias 100Negativity Bias 103The Gambler 105Avoiding Mistake #4—Letting Yourself Get in the Way 106Mistake #5 Working with the Wrong Advisor 107Most Advisors Will Do Far More Harm Than Good 108Advisor Selection Issue #1—Custody 108Advisor Selection Issue #2—Conflict 113Test #1—Independent Advisor or Broker? 114Investment Advisor Defined 114Broker Defined 114So What's the Difference? 115Test #2—Pure Independent versus Independent and Broker 116Test #3—Proprietary Funds versus NoProprietary Funds 117A Final Thought on Conflicts 118Advisor Selection Issue #3—Competence 119Competence Check #1—Do the Advisor's Credentials Meet Your Needs? 120Competence Check #2—Is the Advisor Right for You? 120Competence Check #3—Is the Advisor Following a Process That You Agree With? 120A Final Thought on Advisors—Principles 121Avoiding Mistake #5—Choosing the Wrong Advisor 122Mistake #6 No Mistaking 125Rule #1: Have a Clearly Defined Plan 125Rule #2: Avoid Asset Classes That Diminish Results 127Cash—The Illusion of Safety 127The Illusion of Gold as a Way to Grow Wealth 129Rule #3: Use Stocks and Bonds as the Core Building Blocks of Your Intelligently Constructed Portfolio 131Rule #4: Take a Global Approach 138Rule #5: Use Primarily Index-Based Positions 140Rule #6: Don't Blow Out Your Existing Holdings 140Rule #7: Be Sure You Can Live with Your Allocation 142Rule #8: Rebalance 143Rule #9: Revisit the Plan 144The Ultimate Rule: Don't Mess It Up! 145Portfolio Example 146The "I Want to Beat the Market" Portfolio 146The "I Need 7 Percent to Hit My Long-Term Retirement Goal" Portfolio 146The "Get Me What I Need for the Rest of My Life with the Least Volatility Possible" Portfolio 147The "I Have More Money Than I Will Ever Need and I Want It to Grow with Minimal Volatility" Portfolio 148The "I Have More Money Than I Will Ever Need, Volatility Doesn't Bother Me, and I Want It to Grow Along with the Market" Portfolio 148A Path to Success: Intelligent Portfolio Construction 150You're the One 151Conclusion Let's Roll!! 153References 155Index 163