The 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 xiii

Acknowledgments xv

About the Author xvii

Legal Disclosure xix

Introduction The Market Wants to Be Your Friend xxi

Mistake #1 Market Timing 1

The Idiots 5

Why Is It So Hard to Beat the Market? 6

Efficient Markets 7

The Evidence (Research and Stuff) 8

The Media Get It Wrong, Over and Over Again 8

Economists Get It Wrong, Over and Over Again 9

Investment Managers Get It Wrong, Over and Over Again 14

Newsletters Get It Wrong, Over and Over Again 17

Your Buddy 18

Strategies That Don’t Sound Like Market Timing but Are Market Timing—Oh, and They Don’t Work Either 19

Asset-Class Rotation 19

Tactical Asset Allocation 20

Style Rotation 20

Sector Rotation 20

What Smart Investors Have to Say on Market Timing 20

Knowing All This, Why Would Anyone Market Time? 21

Corrections 22

Bear Markets: An Overview 26

Bear Markets Happen for Different Reasons, but the Outcome Is Always the Same 27

Bear Markets Are Not Predictable 28

When Bear Markets “Turn,” They Make People on the Sidelines Look Silly 30

The Market Is Volatile—Get Used to It 30

You Can’t Wait for Consumers to Feel Good 31

Learning to Accept the Bear Markets 33

Miscalculating the Risk of Market Timing 34

But What If I Am Perfect? 34

Lump-Sum Investing versus Dollar-Cost Averaging 36

Learning to Fly 40

Avoiding Mistake #1—Market Timing 41

Mistake #2 Active Trading 43

The History of Active Trading 44

Active Investment Managers Lose to Indexing 45

Newsletters Lose to Indexing 45

Active Mutual Funds Lose to Indexing 45

Survivor Bias (a.k.a. Mutual Fund Performance Is Even Worse Than the Data Suggests) 47

What About the Winners, Huh? What About the Winners?! 48

Hedge Funds Lose to Indexing 51

Endowments—Misperception of Performance 56

Venture Capital (Sounds Sexy but Usually a Dog) 57

The Taxman Cometh (a.k.a. Dear Goodness, It Gets Worse) 59

Portfolio Activity Hurts Performance 59

But Doesn’t Active Management

Work in a Down Market? 60

Why Indexes Win 61

But Indexing Results in Average Returns 62

S&P 500, Here I Come! 62

Avoiding Mistake #2—Active Trading 64

Mistake #3 Misunderstanding Performance and Financial Information 65

Misunderstanding #1—Judging Performance in a Vacuum 65

Misunderstanding #2—Believing the Financial Media Exists to Help You Make Smart Decisions (a.k.a. the Media Is Killing You) 67

Misunderstanding #3—Believing That the Market Cares About Today 71

Misunderstanding #4—Believing an All-Time High Means the Market is Due for a Pullback 74

Misunderstanding #5—Believing Correlation Equals Causation 77

October Is The Worst Month to Invest 77

Sell in May and Go Away 78

Misunderstanding #6—Believing Financial News Is Actionable 79

Misunderstanding #7—Believing Republicans Are Better for the Market Than Democrats 80

Misunderstanding #8—Overestimating the Impact of a Manager 82

Misunderstanding #9—Believing Market Drops Are the Time to Get Defensive 83

Avoiding Mistake #3—Misunderstanding Performance and Financial Information 84

Mistake #4 Letting Yourself Get in the Way 85

Fear, Greed, and Herding 85

The Overconfidence Effect 89

Confirmation Bias 93

Anchoring 95

Loss Aversion 97

Mental Accounting 98

Recency Bias 100

Negativity Bias 103

The Gambler 105

Avoiding Mistake #4—Letting Yourself Get in the Way 106

Mistake #5 Working with the Wrong Advisor 107

Most Advisors Will Do Far More Harm Than Good 108

Advisor Selection Issue #1—Custody 108

Advisor Selection Issue #2—Conflict 113

Test #1—Independent Advisor or Broker? 114

Investment Advisor Defined 114

Broker Defined 114

So What’s the Difference? 115

Test #2—Pure Independent versus Independent and Broker 116

Test #3—Proprietary Funds versus No

Proprietary Funds 117

A Final Thought on Conflicts 118

Advisor Selection Issue #3—Competence 119

Competence Check #1—Do the Advisor’s Credentials Meet Your Needs? 120

Competence Check #2—Is the Advisor Right for You? 120

Competence Check #3—Is the Advisor Following a Process That You Agree With? 120

A Final Thought on Advisors—Principles 121

Avoiding Mistake #5—Choosing the Wrong Advisor 122

Mistake #6 No Mistaking 125

Rule #1: Have a Clearly Defined Plan 125

Rule #2: Avoid Asset Classes That Diminish Results 127

Cash—The Illusion of Safety 127

The Illusion of Gold as a Way to Grow Wealth 129

Rule #3: Use Stocks and Bonds as the Core Building Blocks of Your Intelligently Constructed Portfolio 131

Rule #4: Take a Global Approach 138

Rule #5: Use Primarily Index-Based Positions 140

Rule #6: Don’t Blow Out Your Existing Holdings 140

Rule #7: Be Sure You Can Live with Your Allocation 142

Rule #8: Rebalance 143

Rule #9: Revisit the Plan 144

The Ultimate Rule: Don’t Mess It Up! 145

Portfolio Example 146

The “I Want to Beat the Market” Portfolio 146

The “I Need 7 Percent to Hit My Long-Term Retirement Goal” Portfolio 146

The “Get Me What I Need for the Rest of My Life with the Least Volatility Possible” Portfolio 147

The “I Have More Money Than I Will Ever Need and I Want It to Grow with Minimal Volatility” Portfolio 148

The “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 148

A Path to Success: Intelligent Portfolio Construction 150

You’re the One 151

Conclusion Let’s Roll!! 153

References 155

Index 163