The 'Seven Deadly Sins' of Investing: What to Avoid

Key Takeaways

There are some common mistakes that investors make time and again. Identifying and helping clients avoid these pitfalls is an area where investment professionals can provide tremendous value.

In no particular order, here are what I consider the “seven deadly sins” of investing:

1. Failure to Properly Diversify

Putting all your eggs in one basket is probably the first and most obvious risk of prudent investing. Concentrating your wealth can have the potential to produce higher returns—but also carries a much higher risk of loss. Most investors need a broad mix of investments to handle market ups and downs over time.

2. Making Knee-Jerk Reactions and Allocation Decisions

Reacting to recent price fluctuations (like selling after a decline or buying after a rise in price) is another classic mistake. Instead, we would argue that investors should focus on investment fundamentals, not on price alone.

Following the crowd is generally a bad idea, and we discourage people from making buy-and-sell decisions without considering their unique situations, goals and requirements.

3. Failure to Distinguish News From Noise

As a rule, by the time you hear something about an investment on TV or in the financial press, that information is already discounted in the price of the security. It’s important to discount the hype cycle and your own personal biases when analyzing the merits of a given investment, and adopt a Sgt. Friday approach: just the facts.

4. Ignoring Asset “Location”

I want to be clear here: You should never allow the so-called “tax tail to wag the investment dog.” But having said that, there is tremendous value to be realized in properly locating your assets in appropriate vehicles (traditional IRAs, Roth IRAs, other tax-deferred accounts, taxable brokerage accounts, insurance trusts, etc.).

Doing so has the potential to improve your after-tax investment performance over the long term.

5. Overestimating Investment Skill in a Bull Market

It’s a truism that when markets are going up, people feel like financial geniuses. This can lead people to overestimate their investment knowledge and skill, resulting in poor financial decisions. This is no surprise: There’s a large body of research supporting the notion that retail investors subtract value through their buy-and-sell decisions.

In our view, investment success comes from setting clear, rational and reasonable goals—and sticking to them. Developing appropriate benchmarks to evaluate and contextualize performance is another key step in assembling and assessing your portfolio.

A solid financial plan grounded in realistic expectations is the best way we know to promote success and defeat this and other financial sins on our list.

6. Chasing Bond Yield

The markets are generally pretty good at processing relevant information. As a result, you don’t get extra return or yield (yield relates to the rate of return for bonds or other fixed-income securities) without taking on some additional risk. There just aren’t a lot of dollars lying around out there waiting for you to pick them up.

In fixed-income land, those risks include interest rate risk, credit quality, liquidity or sector risk, among others. The point is, left to their own devices, investors have a tendency to chase the highest yield or expected return in a category without thoroughly vetting the fundamentals and particular risks of a given investment.

7. Not Paying Attention to Taxes, Fees, Commissions and/or Transaction Costs

You can’t spend your paper portfolio—your return is what you earn after all costs are taken into account. Fees are fine if they’re reasonable and buying you something of value; gratuitous or unnecessary fees are not okay. Similarly, tax mitigation is important, but not at the cost of larger portfolio goals.