The 7 Most Common Mistakes of Investors

This is a very useful list. There are a few here that bear some discussion. “Investing near the top” (#7) is another factor of emotional investing because it is a factor of confidence. The “cycle of emotion”  graphic shows a graph that looks like a steep bell curve with two marks; one near the top of the curve and one, on the other side near the bottom. The one near the top, as you can guess is where the investor finally muster sufficient confidence to re-invest. However, she buys in so near the top that when the market cycles down again she has realized very little gain. The mark near the bottom is the place on the market cycle at which she has become so discouraged that she sells and locks in her losses.

I know a wealthy guy who decided to get his securities license because his family had significant wealth to manage. I never asked him if he took over his family portfolio but I cautioned him about his exposure to his emotions. Just because he had gained the knowledge about professional investment practices, he was still emotionally attached to the portfolio. He had no “arms length” from his money.

The “water cooler” mistake we usually call the “hot tip”. This one is the same mistake as buying on past performance; in this case your buddy has made his; there is no guarantee the ball will keep rolling in the same direction. “Failure to harvest winnings” #6 explores all the emotions surrounding the question about how long to hold. Readers here know that I practice rebalancing in my portfolios. Harvesting winnings is part and parcel of that practice but it should be noted that it is a mathematical determination, not speculative. Perhaps I will return with more critique on this list of 7 mistakes. For now, I wanted to endorse them and share them with my clients and friends.

Investors and the Crisis in Syria

We need to keep in mind the “efficient markets” rule. The financial markets “price in” or account for uncertainties with all that can be known about a situation to that point in time. As the Syria crisis continues to unfold, it will be reflected in the financial markets. As always, as a crisis ebbs, the financial markets will reflect an easing of tensions which increases investor confidence in the markets. Therefore, as markets swing dramatically, investors may want review their current asset allocations against their model portfolios and make adjustments accordingly. Advisors who are vigilant will be viewing their client accounts to determine if the portfolios have become unbalanced due to dramatic market swings. Rebalancing the portfolios will involve buying more units of mutual funds that have declined in value and selling units of those that have appreciated as a result of this crisis. So these crises can represent investor opportunities for financial gain.


“Short sales” and other exotics

Short sales, as this article reveals involves selling borrowed shares hoping to buy them back later at a lower price, creating a profit. The article refers to this as a “bet”. That’s a good characterization of this activity because shorting can be just a gamble. The article reports on a capital management company, “Dialectic” that is a hedge fund. Dialectic holds shares of a company called “Herbalife” whose shares have appreciated significantly this year. In this case, the hedge fund has an opinion about Herbalife’s corporate structure that they believe makes it a perfect stock to short. Herbalife, Dialectic contends is a pyramid scheme. The reader can assume that Dialectic shorted it because if it is a pyramid scheme, it is bound to collapse or be raided by regulators. It hasn’t happened, yet.

I have used hedge funds in my portfolios in the past; selecting portfolios from wealth management companies that hold bond hedge funds. Holding bond hedges makes sense when you are buying bond funds while interest rates are rising. The bond hedge fund will appreciate in value if interest rates continue to rise, while the bond fund will likely depreciate due to the rising rates. Thusly, the bond hedge fund helps to offset the losses in the bond fund. Bond “yields” are  the function of the interest rate or “coupon” of the bond divided by its share price. Prices fall when interest rates are rising because the lower coupon is not in demand against higher coupons available from newer bond issues. That’s why when higher yields are reported, bond investors get nervous. Bond fund managers keep an eye out for inflation or monetary policies that may signal inflation because during inflationary periods, interest rates rise. Most bond fund managers today aren’t seeing indications of inflation.

In my opinion, hedge funds are a “derivative” investment. Derivatives have risk factors that are additional to more straightforward investments. As I have stated elsewhere here, I invest in mutual funds. Sometimes, as I encountered when my portfolios were held at a wealth management company, mutual funds have derivatives in the portfolio; maybe wholly or in part. “Structured” funds are such derivatively-based mutual funds. It is my understanding that “structured” funds may contain securities purchased by the fund with borrowed money or “leveraged”. I have avoided these since I began to manage my own portfolios.

At this time in my practice, I am not holding bond hedge funds in my client portfolios with heavy bond investments. During May, when yields were rising, my bond prices were falling. I used that opportunity to buy more shares of the bonds. The amount I bought was dictated by the relative proportion of the bond holding in the portfolio. I “rebalanced” the portfolio by buying enough shares of the bond to restore its value to the portfolio’s model proportion or its “allocation”.