There are just a handful of reasons why you lose your money investing. Once you understand what causes your investment losses, it will be easier for you to curtail these setbacks. Let’s look at these in order of least to most expensive:
5. Wrong Expectations
The first reason is that investors have the wrong expectations. When they expect “Y” and then get “X,” they get fed up. When that happens, they often take their marbles and go home – and usually they go home with fewer marbles than they came with. The good news is that by understanding this dynamic, you can keep more of your marbles – and money.
Let’s take an example. Let’s say you do your mutual fund evaluation and find a great mutual fund to invest in. You have great expectations for wild profits. After all, when you look at the track record, you see fantastic profits for other investors. Why shouldn’t you get your share? (Gold investors are a great example of this phenomenon.)
So, after careful consideration, you plunk down your money. Then the market “turns against you.” You might be able to sit out a certain measure of time, but after a while, your emotions are going to get control and you’re likely to sell. You tell yourself that the fund is, after all, a clunker and you get out. Let’s consider what really happened here.
The market didn’t turn “against you.” The market just did its thing. And the fund may not be a clunker either. Most ships rise and fall with the tide. The same can be said for mutual funds. If the market turns, your fund is likely to get pulled out to sea like all the other funds.
What turned was your emotions and nothing else. You had the wrong expectation (quick profits), and when reality set in you got disappointed. You went from over-exuberance to depression. You had the wrong expectation when you entered the investment, and ultimately that is what caused you to lose money. It was only a matter of time before reality dashed your misguided optimism. Read my post on “Why Smart People Are Still Losing Money” for a deeper discussion.
4. Statistics
Another major cause of losses for investors is that they invest without understanding the real risk they are taking. If you look at investing over the last 100 years, you might conclude (these are all made up numbers) that you have a 95% chance of earning a positive return if you hold on to your funds for at least five years. People hear that and think they can’t possibly lose money. They focus on the 95% chance of success and tell themselves that the 5% possibility of losing money can’t possibly happen to them. They see the statistics, but ignore them. This problem is true for buy-and-hold investors as well as those who use market timing strategies.
3. Oversimplification
Nobody likes complications. But just because you like to keep things simple doesn’t mean that’s the way the world works. If you are making an investment, make sure you understand all the complexities – not just the elements of the deal you feel most comfortable with.
2. Wrong Time Frame
This is tied into the first problem, which is having the wrong expectations. But having the wrong time frame is a bit different. Sure, you need to have your mind right as to what investment performance you should expect over a given period of time. But you should also make the right investments to match your personal time frame. Example.
Let’s say you need $15,000 to buy a car in 18 months. You don’t want to keep that $15k sitting around in the bank earning nothing, so you buy a mutual fund and figure you’ll just pull the money out when you need it.
Wrong.
18 months is not enough time for your funds to grow. You might get lucky of course, but you might not. If things go wrong, you might be stuck getting around town on your Schwinn bike rather than buying that car you’ve had your eye on. If you have a short-term time frame for money, don’t invest in long-term investments. OK?
1. Failure to Launch
The number one reason people lose money is because they fail to invest. More money has been lost sitting on the sidelines than by careful, considerate investing. I know that last decade has been tough for investors – but what’s important to me is what’s going to happen over the next decade.
If because of your false expectations, wrong time frame, oversimplification and failure to understand risks, you allow yourself to keep your money locked up in the bank earning next to nothing, the odds are high that you’ll earn very little.
On the other hand, if you take the time to understand investing, make sure you have the right expectations about your investments, have the right time frame and understand the risks, the chances are good that you’ll be able to make smart investments and grow your money.
What have been the most expensive investment mistakes you’ve made? How did you correct them? What was the result?
Hello neil very good investing information your articles are a good read .
N eil if you can shed some of your thoughts on leveagring loans investments where you pay interest only I have been involved the last couple of years and I have really taken a hit mainly because of situation out of our control fical cliff and the economy and Europe suggestions please on how to handle this and I was wondering if you have a blog on this subject on leveraging and loan investments when you have spoken about this my age is 57 and retired please feel free to send me some feedback when you have the time
T hanks Terry
Terry, I am confused. You have borrowed money and can’t repay or you have invested i non-performing loans?
You can make a case for any of those points, but we’ve lost a lot of money in our 401K that never came back, even after 15 years. I’m very skittish of today’s market with all of the Eurozone turmoil. Perhaps after it settles down again will be a better time to invest in the stock market.
@Maggie, yes….those last years have been difficult and I understand your skittish feelings. I also understand your case for continued turmoil. Unfortunately, my experience tells me it’s very difficult to predict the market. Look at 2009 and 2010 as a great example. My motto is to follow the market rather than predict it. Anyway, thanks for your thoughtful comment.
I think you hit the nail right on the head with your number one reason for losing money in investing.
As far as your point on statistics it often depends on what point of view you take (analytic, fundamental or some view of both). However I believe we have plenty of resources (statistics) available to us as investors to make the right decisions as we see fit. Not only do we have all of the financial information of the company in question with CAPS and TheStreet but we also have excellent resources like Trefis that gauge the product or service of a company and how that values a stock. Besides that investors have a slew of blogs like yours and mine to use at their disposal. Thus, investors are failing to take advantage of these if they are failing in their use of statistics.
Oversimplification can be a problem but may be beneficial to a buy and homework, not buy and hold investor. Using simple metrics for proven companies that are perennial winners with dividends may be oversimplification for some.
I completely agree with you on expectations. I thought this myself when I made my first buy; “it will go through the roof tomorrow.” This goes back to having a sense of time that you mentioned. Do I expect this holding to benefit in the short term or long term and how?
Another extremely important point I would add are taxes and trade fees. Even with DSP and DRIP programs (most programs) have fees. Failing to compute these will cause a failure in earnings. This also comes from trading too often if you are not qualified to do so or trading such small amounts of money that the brokerage fees are worth more than the shares of stock!
Overall, thank you for the post. It is exactly what readers are looking for and I will be sure to stop back and give more thoughtful comments.
@Youthful…..wow….a great and thoughtful response. I respect your views. And thanks for bringing up the issue of taxes and costs.
Timing…especially on the short side is extremely difficult. It’s even tougher when you use options. Sounds like you have a good risk abatement policy in place. Nice.
My most expensive investment mistake has definitely been trying to time a market short using put options. Although the market did end up dropping dramatically, it happened a few weeks after my put options expired.
I try to limit the size of my short term trades to just 5-10% of my overall portfolio taxable portfolio (I’m 100% long in Roth IRA & Roth 401k). I also use unleveraged ETFs now, so I don’t have to worry about having the right trading idea but timing that may be slightly off.