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The Deadly Dozen: Investment Pitfalls to Avoid (Part 1)

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There are a dozen vital mistakes any investor must avoid to realize one%u2019s financial stability. All these can be reduced into two general ideas, namely:

1.       The Golden Way %u2013 Gaining insight from the investment mistakes of other investors

2.      The Costly Way %u2013 Gaining experience and knowledge yourself in the school of hard knocks

Who would want to choose the more difficult and costly method when you can learn the same things indirectly from others%u2019 mistakes? And the good thing is that you can get those lessons right now! Here are the Deadly Dozen to avoid as an investor:

Deadly Mistake #1: Diversify, Do not Diworsefy

Creating a diversified portfolio helps you to manage risk wisely, if done properly. This means adding a new asset that has a different risk level.

For instance, you can diversify a portfolio consisting of U.S. stocks by inveasting in non-related markets such as gold, gold stocks, bonds, commodities, real estate and other asset types that present low or inverse correlation.

%u201CWise men profit more from fools than fools from wise men; for the wise men shun the mistakes of the fools, but fools don%u2019t imitate the successes of the wise.%u201D Cato the Elder put that very wisely. However, not many are wise enough to listen to good advice.

The mistake is to %u201Cdiworsefy%u201D by adding other assets that have similar risk profile leading to your investment performance imitating the averages. As an example, augmenting U.S. equity mutual funds to a diversified U.S. stock portfolio is di-worse-ification.

The objective in diversification is to add uncorrelated and even contrasting sources of revenue. This will minimize portfolio hazards and potentially enhance total benefits when augmented further by effective investment strategies.

Deadly Mistake #2: Instead of Picking Stocks, Allocate Assets

Various research investigations seem to reinforce the findings that about 90% or more of the variance in a diversified portfolio%u2019s revenue arise from allocation of assets.

Unfortunately, majority of people make the error of concentrating 90% of their time and effort on the remaining 10% of gain by picking individual securities. It simply defies reason.

Robert J. Shiller defines true intelligence for us thus: %u201CThe ability to focus attention on important things is a defining characteristic of intelligence.%u201D

Don%u2019t make the mistake of spending all your time on the decisions that will make little difference in your overall performance.

Avoid, therefore, imitating so-called failed experts who consistently pick the newest hot stock or the best-performing fund in the market.

The better alternative is to take enough time protecting your resources by finding the proper allocation to asset types and strategies. This essentially applies Pareto%u2019s Law (the 80-20 rule which expects 80% of your outcomes to arise from 20% of your efforts) to your advantage. 

Deadly Mistake #3: Historical Returns do not Guarantee Similar Performance

If your financial counselor tells you that the average annual historical returns of 10% from the U.S. stock market (could be 7% or 8% according the exact era and duly adjusted for inflation and dividends) will serve as a dependable guide, doesn%u2019t mean you should expect similar.

More often than not, the future will be far from the historical mean. Moreover, your average holding time may not be sufficiently long to reproduce average revenues.

The usual holding period average relative to majority of long-term historical stock revenue evaluations is at least 30 years. And though you may have been an investor for 30 years or more, you may only have less than half of that at most as your average holding time. The collective wisdom of the entire market is much greater than that of the oldest investor in the world.

Remember that most of your savings are expected to be accumulated late in your professional career and put to actual use during your retirement. It is rare for anyone to start investing at 30 years old with a sizeable amount and retiring at 60 years old on that investment to produce a 30-year holding period. That happens only in our dreams.

The reality presents a less than desirable picture of variability in predicted returns compared to long-term average indications. In short, average returns are statistical improbabilities. Nassim Taleb, author of %u201CFooled by Randomness,%u201D says that the average return on the Dow Jones Industrial Average for the period 1900 to 2002 was 7.2%. During the 103-year period, there were but 5 years with returns from 5% and 10%. Apparently, the so-called %u201Caverage%u201D is just not common.

%u201CA reasonable probability is the only certainty,%u201D said E.W. Howe.

Lastly, long-term averages may not bear any real significance to your present investment circumstances since today%u2019s investment climate or situation is far from being typical.

For instance, not many investors are aware that the holding period revenues for their stocks are correlated inversely to the initial valuations of the holding duration.

That means, if stock valuations are greater than average at the start of your investing period, you stand to obtain 7-15 year revenues below the average.

On the other hand, If stock valuations are below average when you begin investing, you can fairly expect 7-15 year revenues above the average.

Ultimately then, all the good heard about long-term probabilities and average returns may actually have nothing to do with the results you will obtain.

Avoid making the mistake of using historical average revenues to create your investment plan, no matter how long your holding period may be.

Obviously, investing is not that simple and straightforward; otherwise, many would have been successful. Remember; do not use historical returns as basis for building a portfolio.

Deadly Mistake #4: Investing Minus a Plan

Some people spending more time planning their vacation than planning their financial security.

Many studies show that individuals who meticulously write down an investment plan has more chances to leave their contemporaries behind, not by a few percentage steps but by big leaps.

Build up your financial future by producing a balanced plan grounded on solid statistical projections; because a baseless plan is guessing or gambling not investing.

Various investment approaches utilize Expectancy Investing guidelines; and all of them must be implemented with great discipline for many years to guarantee ultimate success.

This requires to never %u201Cinvest%u201D (that is, gamble) on hot tips, rumors, stories, guessing, foretelling performance or expecting the market to go up.

You need a plan founded on well-researched constructive expectancy; all of the above methods are devoid of any semblance of a proper plan even though many often apply them.

Your financial well-being requires a better alternative. As John Lennon once said, %u201CLife is what happens to you while you%u2019re busy making other plans.%u201D

Deadly Mistake #5: Not Investing in Your Financial Education

Learn comes before earning. Improving yourself intellectually means investing in your future financial security.

Investing done right is both an art and a science. For that reason, you must avoid swallowing half-truths and oversimplifying, thus, neglecting the nuances of the investing process.

Investing can be considered an art as it involves using deep human emotions even though we often try to present ourselves as rational-thinking beings. In reality, many of our decisions are greatly influenced by our moods, values, communal psychology, fears, passions and desires. Still, we continue to delude ourselves that we use pure logic in making investment decisions.

Will Durant said something which covers this masquerade: %u201CEducation is a progressive discovery of our own ignorance.%u201D

Nevertheless, investing can be seen as a science for it demands an effective method founded on proven scientific concepts, such as asset allocation, diversification, correlation, valuation, probability and others.

To succeed in investing on a long-term basis, we need to balance the two. You need to focus on improving yourself and your decision-making capability as also you enhance your expertise in investment strategy.

FinancialMentor.com was conceived precisely to improve your financial IQ and thereby help you create lasting wealth.

Nothing is more financially risky than an investor making decisions worth a million dollars but possessing a financial intelligence worth only a thousand dollars.

Like in most things in life, a little financial knowledge can truly be a dangerous thing; but a lot of knowledge can bring lots of benefits.

Investing to improve your financial intelligence will bring a lifetime of benefits.

Deadly Mistake #6: Failing to Match Investment Style with Your Personal Objectives

People often make the foolish mistake of aiming for success by leaning their ladder of investment against the wrong wall.

Although there is no hard-and-fast rule to attain financial success, there will be one correct answer that will be suited to your needs and circumstances.

Your task involves looking for the method that will be consistent with your objectives, skills, resources, values and risk profile such that you will attain wealth and personal satisfaction. A financial guru%u2019s own phenomenal success is exclusively his own; his approach does not necessarily apply in your own situation.

Likewise, if your investment counselor is successful at his work of selling paper assets, such as (bonds, stocks, insurance, mutual funds, etc.); it does not follow at all that you cannot also make sufficient earnings in other paper assets, such as real estate or your own enterprise. In investing, there is no such thing as one-size-fits-all phenomenon.

You need to realize that your road to financial security requires finding the appropriate size for your own use alone.

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