Author Topic: Why individual investors fail.  (Read 4281 times)

TomTX

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Why individual investors fail.
« on: December 14, 2014, 08:28:59 PM »
My own personal opinions, ranked in order: The reasons individuals FAIL as investors.

#1: They never invest at all. Whether it's caused by a consumption lifestyle or analysis paralysis - the average person never invests. Frequently they are ignoring a FREE doubling of their money through 401(k) matching.

#2: They go down the rabbit hole of complexity, ending up trying to outguess the markets - whether through "overweighting undervalued sectors" or full-blown option gambling. Once burned, they cash out at the bottom of the market, or throw up their hands and move on to mistake #3.

#3: They invest with high-cost "advisors" who siphon off a huge amount of the potential growth.

#4: They don't optimize for taxes. They ignore how various IRAs and HSAs can help their total return.

What SHOULD the individual investor be doing?

Invest. Invest in a low-cost, tax advantaged account - for example, since you are reading here and already get your full 401(k) match - max out your 2014 ROTH IRA in VTSMX right now.  Next month, max out 2015, and get it upgraded to the lower-cost Admiral shares version. You are doing the same for your spouse, right?

Once you have $50,000 invested - ONLY then, can you think about branching out into an asset allocation with something like a low-cost bond fund and periodic rebalancing. Or wait until you have $100k.  Or more. No rush.

Once you have $250,000 invested - ONLY then, can you think about maybe weighting small cap or something else. If you REALLY REALLY feel you have to. Maybe wait for $1,000,000. Or $2MM.

sb_NoVA

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Re: Why individual investors fail.
« Reply #1 on: December 15, 2014, 02:14:08 AM »
Thanks!  You are correct on so many levels.  We are victims of our own self-belief that we somehow know the unknown and can predict something better than next guy down the block.  Been there, done that. 

ScroogeMcDutch

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Re: Why individual investors fail.
« Reply #2 on: December 15, 2014, 02:38:12 AM »
With all due respect, you would have to know a couple of things more before you can say individuals fail as investors.

- You don't know what this individual is trying to accomplish in life financially
- You don't know what risk appetite and emotional maturity this individual has
- You don't know what benchmark this individual would want to meet
- You don't know how much faith this individual has in the system/world we live in

Granted, answers for many of those can be assumed, and then your statement would hold merit, but I can think of examples for each of 1 through 4 in your list where a different outlook turns FAILURE into SUCCESS compared to his other options, considering his point of view. You can argue their original point of view, but don't extrapolate your point of view onto theirs, and elevate your criteria of success to generic, global, all-truth criteria of success.

Let me peel it down:

#1: They never invest at all. Whether it's caused by a consumption lifestyle or analysis paralysis - the average person never invests. Frequently they are ignoring a FREE doubling of their money through 401(k) matching.

These are two separate points. Some people cannot stand to lose money at anything. They are the type of people who should probably stay away from the stock market, as they will scream at the moment a -10% dive happens and take money off the table. As such, they're the biggest suckers when it comes to investing.

The 401(k) matching is more questionable, and I doubt this is an issue in the US of A, but I do hear these worries over here in Europe, where faith in the entire pension system is degrading. Basically, if you save enough money yourself, people are starting to count on that the Social Security benefits you'll get will be cut and reduced compared to people who haven't saved in a pension system. If this is a conviction you have, then consuming now could be a better choice than consuming in the future.

#2: They go down the rabbit hole of complexity, ending up trying to outguess the markets - whether through "overweighting undervalued sectors" or full-blown option gambling. Once burned, they cash out at the bottom of the market, or throw up their hands and move on to mistake #3.

This relates to the point of what is the financial plan of the individual. Maybe he wants to generate generational wealth and is willing to take massive risk to get there, as opposed to just financial independence that is strived for on this forum. Maybe the downside of him tanking and losing his shirt is very low, as he can count on governmental money to keep him supported.

#3: They invest with high-cost "advisors" who siphon off a huge amount of the potential growth.

Depends on the maturity of the individual to keep the faith in his DIY plan for investing. My guess is many of them will second guess the decisions they make, will start shifting things around as soon as a market tanks, and maybe they will also do this with their high-cost advisors. On the other hand, the fallacy of "they're paid well, so they must know better and beat the market" may give these individual investors the peace of mind that they need to keep money in the market. And yes, this probably means their returns are lower than the market returns, and this may just be fine for the individual investors choosing this route.

#4: They don't optimize for taxes. They ignore how various IRAs and HSAs can help their total return.

Unsure exactly how these rules are in the US, and this is the point I agree with most. If you'd expect a large increase in income taxes then not using IRAs could be a wise choice.


I could understand your comment for a blogpost, but not for a forumpost. One size does not fit all, and you are not the person to say if someone else fails or succeeds at a benchmark that you have in your mind and did not make explicit. According to you, when does an investor succeed and when does he fail?

What I do agree with you is that the average individual fails to make a (thorough) personalized rational and emotional analysis of the decisions they make and the context in which they make them. That goes for most decisions (buying vs renting, insurance, cars, lattes at work, eating out, kids, marriage, you name it).


TomTX

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Re: Why individual investors fail.
« Reply #3 on: December 15, 2014, 05:42:55 AM »
I'll respond inline with italics, as the whole quote/dequote gets problematic.

With all due respect, you would have to know a couple of things more before you can say individuals fail as investors.

Not really. For occasional people, perhaps. As a mass - this is how they are failing


- You don't know what this individual is trying to accomplish in life financially
- You don't know what risk appetite and emotional maturity this individual has
- You don't know what benchmark this individual would want to meet
- You don't know how much faith this individual has in the system/world we live in

These either don't matter, or are the contributors to failure.

Granted, answers for many of those can be assumed, and then your statement would hold merit, but I can think of examples for each of 1 through 4 in your list where a different outlook turns FAILURE into SUCCESS compared to his other options, considering his point of view. You can argue their original point of view, but don't extrapolate your point of view onto theirs, and elevate your criteria of success to generic, global, all-truth criteria of success.

Let me peel it down:

#1: They never invest at all. Whether it's caused by a consumption lifestyle or analysis paralysis - the average person never invests. Frequently they are ignoring a FREE doubling of their money through 401(k) matching.

These are two separate points. Some people cannot stand to lose money at anything. They are the type of people who should probably stay away from the stock market, as they will scream at the moment a -10% dive happens and take money off the table. As such, they're the biggest suckers when it comes to investing.

Absolutely, there are people who cannot stand to lose money at anything (but often can waste money on buying crap) Doesn't matter. If they cannot stand to lose money at anything, they have failed at investing. Ether by never investing, or by panicking when an investment goes down. You're actually supporting my position of Mistake #1 by further explaining why people make the mistake.

The 401(k) matching is more questionable, and I doubt this is an issue in the US of A, but I do hear these worries over here in Europe, where faith in the entire pension system is degrading. Basically, if you save enough money yourself, people are starting to count on that the Social Security benefits you'll get will be cut and reduced compared to people who haven't saved in a pension system. If this is a conviction you have, then consuming now could be a better choice than consuming in the future.

So, they are failing at investing because they are scared of an un-knowable future. Doesn't matter. They have failed at investing.

In the USA, many companies "match" contributions to these accounts, up to a certain amount. You put in $100, and the company puts in another $100 which becomes yours (subject to certain rules.) Invest, and you double your money. For free. Other companies might only give you $50 when you put in $100, or other variants. However, the point is made.


#2: They go down the rabbit hole of complexity, ending up trying to outguess the markets - whether through "overweighting undervalued sectors" or full-blown option gambling. Once burned, they cash out at the bottom of the market, or throw up their hands and move on to mistake #3.

This relates to the point of what is the financial plan of the individual. Maybe he wants to generate generational wealth and is willing to take massive risk to get there, as opposed to just financial independence that is strived for on this forum. Maybe the downside of him tanking and losing his shirt is very low, as he can count on governmental money to keep him supported.

Generate generational wealth by taking on massive risk? Yeah, that's gambling, not investing. As a bonus, it usually means that they lose bigtime - either by guessing wrong (hey, I can make HUGE money in options!) or by being scammed. The 'financial plan' as you present it is irrelevant to whether they succeed as an investor. Again, this is more proof of how people make the mistake, not a refutation.

#3: They invest with high-cost "advisors" who siphon off a huge amount of the potential growth.

Depends on the maturity of the individual to keep the faith in his DIY plan for investing. My guess is many of them will second guess the decisions they make, will start shifting things around as soon as a market tanks, and maybe they will also do this with their high-cost advisors. On the other hand, the fallacy of "they're paid well, so they must know better and beat the market" may give these individual investors the peace of mind that they need to keep money in the market. And yes, this probably means their returns are lower than the market returns, and this may just be fine for the individual investors choosing this route.

These are excuses for failure, with a germ of truth. If a high cost "professional adviser" is the only thing that can get someone to avoid Mistake #1 and Mistake #2, they are better off making Mistake #3. However, they will be even better off by developing a moderate amount of self reliance and self control and avoiding Mistake #3 as well.

Thinking that a professional advisor will 'beat the market' is a major problem as professional advisors typically fail to beat the market (especially once you count the costs) - what then? The market tanks, the professional management doesn't 'save' the investment and the investor sells at the bottom anyway. Or they stick through it, but end up with significantly poorer returns than if they made the same investments in a low-cost manner.



#4: They don't optimize for taxes. They ignore how various IRAs and HSAs can help their total return.

Unsure exactly how these rules are in the US, and this is the point I agree with most. If you'd expect a large increase in income taxes then not using IRAs could be a wise choice.

I could understand your comment for a blogpost, but not for a forumpost. One size does not fit all, and you are not the person to say if someone else fails or succeeds at a benchmark that you have in your mind and did not make explicit. According to you, when does an investor succeed and when does he fail?

Excellent point about what constitutes success. It can be hard to define - as you may then have to define the terms used in the definition. Here's my stab at it:

A successful investor is one who has invested a meaningful fraction of the money available to them, and achieves long-term, real* returns

What I do agree with you is that the average individual fails to make a (thorough) personalized rational and emotional analysis of the decisions they make and the context in which they make them. That goes for most decisions (buying vs renting, insurance, cars, lattes at work, eating out, kids, marriage, you name it).

Thanks for the conversation!

*"Real" means they beat inflation. Yep, I am setting a low bar - you can achieve it while still making Mistake #3 and Mistake #4.

Le Barbu

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Re: Why individual investors fail.
« Reply #4 on: December 15, 2014, 06:47:03 AM »
ScroogeMcDutch, did you "failed" at investing or ever invested?

TomTX just exposed the "fail" mirror of the "4 tips to succed at investing" list

1-save & invest
2-diversification
3-low fees
4-minimise taxes

I think you fail at swiming if you dont get wet, no matter the rest of your life

ScroogeMcDutch

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Re: Why individual investors fail.
« Reply #5 on: December 15, 2014, 07:13:59 AM »
I started investing this year after reading up on a lot of the theory on this site and other sites. It started with the thought of "this money should be doing something" combined with a fear of "stock market is all crooks and gambling" and had to go through the process of defining what I wanted to accomplish financially, what the tax repercussions were of my plan, and lots and lots and lots of reading.

Step 0 of both lists should be to define what your goals are, otherwise the rest of the list is relatively useless.

I was very glad with the response TomTX gave to my answer, as I agree with all of his answers. I understand the train of thought. To be honest, I was a little afraid I came across as cross in my reply and was relieved to see his well thought out response.

Same as with your swimming example.

If you want to get across the pool, you can learn how to swim, get wet, and swim across (invest in index funds).
Or you can walk past the side of the pool (saving only cash).
Or you can ask someone to swim you across (high cost advisors).
Or you inflate a boat and paddle across (start a business)

If you don't set the goal (getting across a 50m pool) then how can you know if you succeed or fail at swimming? Does someone who is swimming for 2 hours in the ocean before drowning, fail or succeed at swimming?

wtjbatman

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Re: Why individual investors fail.
« Reply #6 on: December 15, 2014, 07:20:30 AM »
Put the word "some" in between the words why and individual in the thread title and we can avoid this argument.

Then we could just argue about whether it's more accurate to say "some" or "most" :)

Schaefer Light

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Re: Why individual investors fail.
« Reply #7 on: December 15, 2014, 07:28:27 AM »
Based on conversations I've had with co-workers, I think most people play it way too safe with their investments.  The stock market goes down and they talk about switching all of their funds to bonds or other really conservative investment options.  That's the absolute worst thing to do right after a crash.  I'm young, so I like a good stock market "correction".  It allows me to buy more shares.

Le Barbu

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Re: Why individual investors fail.
« Reply #8 on: December 15, 2014, 08:03:40 AM »

If you don't set the goal (getting across a 50m pool) then how can you know if you succeed or fail at swimming? Does someone who is swimming for 2 hours in the ocean before drowning, fail or succeed at swimming?


Do you really mean swimming is the same as getting across a 50m pool?

Someone could manage to never get in $$ issue of any kind in his whole life without "succeeding" as an investor.

If you don't set a goal, you cannot fail indeed, but does it mean you succeed because you don't fail?

The ocean swimming question is a good one. Could you say he succeeded at swimming but not at staying alive? At least, he succeeded for 2 hours. If someone who "past the side of the pool, ask someone to swim you across or inflate a boat and paddle across" (in the pool exemple) fall off a boat off-shore, they may fail a lot faster than that!

wbrianwhite

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Re: Why individual investors fail.
« Reply #9 on: December 16, 2014, 08:51:40 PM »
#2: They go down the rabbit hole of complexity, ending up trying to outguess the markets - whether through "overweighting undervalued sectors"

Overweighting small cap is a good long term strategy, small cap outperforms the general market over the long term because institutional investors can't really invest there. 

Individual sectors is riskier.  Healthcare is a long term outperformer for capital gains.  Utilities are high dividend payers.

Yes basic index funds should be the core of your investing.  But it doesn't have to be 100%. 

YoungInvestor

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Re: Why individual investors fail.
« Reply #10 on: December 16, 2014, 10:01:03 PM »
As a canadian, I'm not a huge fan of indexes as some sectors are way too prominent.

I prefer buying and holding individual companies that I like.

There's something nice about owning part of a company that you like. To me, at least.

My pension plan is mostly just index funds, but the rest ofymoney is in individual stocks (and sometimes options). The entertainment factor alone is worth the few fractions of percents this may be costing me in the long run. I love going through financial reports to find my next investment.

Le Barbu

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Re: Why individual investors fail.
« Reply #11 on: December 17, 2014, 06:46:37 AM »
As a canadian, I'm not a huge fan of indexes as some sectors are way too prominent.

You know you can invest outside Canada? VTI, VBR and VXUS represent 70% of my stash

Last time I checked, RY is less than 2% of my entire portfolio as my only Canadian holding is ZCN