10 Investing Traps To Stay Away From

After 38 years in the investment business, most of that having been in a position to make investment decisions for other people’s money, I’ve learned plenty of lessons. In fact, I am with the many folks in my position that continuously remind investors, especially self-directed types, that we learn so much more from our investing defeats than successes.

Part of what we learn is what not to do or not to do again. In this article you will find a list from my experience and those of many other tenured professional investors.

What Are Investing Traps?

Investing is so much more than what it appears to be to many newer investors. The past 15 years following the global financial crisis from 2007-2009 is when many investors learned. In fact, there’s a good chance that if you are under 55 years old, you might approach this article very differently from those who were later in their careers when that latest extended market malaise occurred.

The sharp declines of late 2018 and 2020 could have been missed by people who went on a long cruise at sea with no internet. And the 2022 decline in stocks and bonds was “merely a flesh wound,” to quote an old Monty Python movie, since stocks roared back the following year.

An investing trap can be something you ignored but should have recognized sooner. It can also be something you have never experienced and were not prepared for. Overall, I believe that most traps have their roots in some combination of complacency, overconfidence, lack of research and believing sources because you know them. With that as a cheery introduction, let’s run through 10 of the most common investing traps.

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10 Investing Traps to Stay Away From

1. Overconfidence Bias

At the top of the list is overconfidence, which is something borne out of years in which things always turned out okay. As I alluded to above, it has been a while, 15 years in fact, since long-term damage was done to investors in traditionally-allocated portfolios. The stock market has been deceivingly strong. I say that because it has been carried by the same smallish group of outstanding companies.

Nothing can lead to overconfidence like that. Here’s a simple guideline to keep this from becoming a financial nightmare the first time you “buy the dip” and see your account lose a digit or two. Never, ever assume that anything in investing is a 100% probability. There’s no such thing. Starting with that inherently defensive attitude can stop emotions from running too high.

2. Chasing Past Performance

Chasing performance is the number one thing I have seen ruin investors over the years. The reason is simple: despite every fund advertisement being required by regulators to state that “past performance is no guarantee of future results,” Wall Street has been two-faced about that.

Presentations and promotions have always emphasized past performance. At least for the past few decades. That has created a false sense of confidence from investors. I cannot overemphasize how often I’ve listened to investors tell me the reason they own something is because it did very well before they bought it. There is often not enough emphasis on the market conditions that allowed that performance to occur, and whether those conditions still offer the same potential.

Past performance does guarantee one thing: You can’t have it! It is in the past. Keep that front of mind.

3. Not Diversifying Your Portfolio

The quick corollary to this is not to over diversify, or what we sometimes refer to as “de-worse-i-fication.” That’s where you think you are diversified and this has lowered your portfolio’s risk. But in reality, you just own the same thing in many forms.

As recently as the morning I wrote this article, I saw an alleged investing “expert” list 10 funds they owned. The funds themselves were okay. But they overlapped so much, it was akin to the old quote from Henry Ford about his Model T automobile in the early days: “the customer can have any color they want, as long as it’s black.”

The S&P 500 is far less diversified as it once was. And it looks a lot like it did back in 2000, at the height of the dot-com bubble. A small number of stocks, and everyone owned them since they owned index funds. Then, those stocks fell hard, and the index was suddenly unmasked as not being as “diversified” as you’d expect from a 500-stock basket. That’s because, as is the case today, the bottom 450 take up so little space in the index, they almost don’t matter at all.

4. Trying To Time The Market

The biggest issue with the never-ending debate over “timing the market” is how we define it. Because every investing decision requires some sort of timing decision. If an investor decides to contribute to their 401(k) plan with every paycheck and they are paid every second Friday, that’s a conscious decision.

But when it comes to market timing, critics typically explain it with the tone that implies that no one knows how to make investment decisions based on a process they develop and follow consistently. Plenty of investors (myself included) spent decades honing our craft.

I’ve written about my yield at a reasonable price (YARP) dividend stock investing approach on Forbes.com and other sites this year. That’s just one example (albeit a personal one) of where it really all depends on whether investing is a profession or “critical hobby” intended to be a big part of one’s financial life, or if it is a necessary evil. In the latter case, long-term investing, buy and hold, index fund types of investing can be helpful substitutes for intense and continuous research and experienced decision-making. But not everyone goes that route. Some of us commit to it, and over time learn how to navigate many types of markets, and invest across all time frames.

5. Ignoring Fees And Expenses

I will be the first to tell investors that fees and expenses are often given too much attention. When I was an investment advisor and my focus was allocating among ETFs, the last two things I covered in my research were expenses and past performance. Because before you can decide if something is priced correctly (fees, not valuation), you have to conclude how valuable it is to your overall portfolio.

For instance, I have used “inverse ETFs” since they were first created last century. They aim to perform opposite a market index, essentially acting as “short” positions to limit risk of major loss. Their expense ratios are typically close to 1%.

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6. Emotional Investing

Let’s be clear on this. Emotions can harm investors in two ways. If someone is too pumped up after seeing some tech stock or cryptocurrency they piled into fly higher, that’s a time to level out the greed. And likewise, there’s no such thing as a market where nothing works. So getting down in the dumps is not a rational choice either.

7. Falling Into Herd Mentality

In the age of social media and the related social pressures, this can be hard on younger investors. However, the best way to defeat this trap is to do your own work. Develop an investment philosophy, process, regimen and “guardrails” around it (risk management approach).

Even if someone is working with an advisor, it is ultimately in the investor’s hands. The more educated someone is, the better chance they can block out harmful noises. Because they develop their own sense of what they want, and what makes sense to them. This could be the most underrated of the 10 on this list. It is in control of every investor. They alone choose to relinquish that control.

Even when a professional is hired, I can truly say that my best clients when I was an advisor were the ones that tried to think and learn along with me. Not questioning my decisions, but seeking to better understand them. Over years and decades, they feel a part of the process, but in the proper role of “CEO” over their own investing, with a hired hand to handle the execution of the strategy they describe in plain English.

8. Neglecting Risk Management

The problem with risk management is that a lot of people talk a good game in the investing business. But too often, they don’t define risk carefully enough.

I have always been a defense-first investor. That might have something to do with my late father, a self-directed investor who mentored me early in my life, being a child of the Great Depression. As a result, my first instinct is to determine what can go horribly wrong. Then, work up from there.

I think all investors should think that way, but too often they fall for Wall Street’s common definition of “risk” – underperforming the broad stock market. That’s not risk management. The S&P 500 can rise or fall 40% in a year, or more. That is not the range of returns many desire.

I have a simple risk management test I used to do with new clients. It is a one-question “risk tolerance test.” The one question: if your best and worst 12-month period as an investor were the same percentage (or dollar) figure, just with a minus sign in front of the maximum loss in your comfort zone, what’s your number? Think about that as a starting point.

9. Not Doing Research And Due Diligence

This, too, is a two-part subject. There is enough research, which no one has an excuse not to do today. There is so much out there for free or at a very low cost, you can operate your personal research process with a low budget or no budget at all. Just a phone or computer will do.

However, where many veer off course when doing their own investing is that they mistake salesmanship and hype for research. I’ve been in the investment publishing business for about three years since selling my advisory practice. And during that time, I have seen a consistent pattern of behavior. Investors see the hype, fear missing out on whatever they’re selling, and buy into it. About three months later they move on, and the cycle keeps repeating. Many of my fellow investment newsletter writers rely on this, spending nearly all their revenue on advertising. Because they have learned over time that as long as their “churn” rate of subscribers is consistent over time, their profit margins will be too. As much as I’m frustrated to see that as a former fiduciary advisor and investment and fund manager, it seems to be a tale as old as time. That’s what happens when money is involved. Don’t fall for it. Be as critical a thinker as you can. Be skeptical of everything, but find your way around the masses of information now out there to consume.

10. Overtrading

Trading in high volume itself is not an issue, if there’s a good reason for it. The key is for each investor to determine their trading process as a byproduct of the aforementioned philosophy, process, strategy and risk management approach they create, borrow or have created for them.

Bottom Line

Investing is not a sport. And it is not a competition against others. It is often against our own worst thinking bad habits. But as with anything worth having, if you put in the time, stay within yourself and aim for the middle emotionally, these common traps and many others can be avoided.

And, since investing is very much a cumulative learning and earning process over time, analyzing your own behavior and technique is a continuous exercise. Mine started with my dad teaching me to chart stocks when I was 16. And 44 years later, I still learn every day in this field, on this journey. I wish you well with yours.