7/30/2019 The Seven Deadly Sins of Investing

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| Wed n e sd ay , Sep tem b er 4 , 2 0 1 3 TIIE WALL STREET JOURNAL.INDEPTHThe Seven Deadly Sins

Of InvestingFinancial Crisis Be DamnedInvestors are Still Making the Same Mistakes They Always Have.Here Are Their Biggest Blunders and How to Avoid Themi t c o m e s t o i n v e s t o r b e h a v i o r t h o s e h a r d -w i r e d i n s t i n c t s t h a t d r i v e u s a l l l i t t l e h a sc h a n g e d , s a y p s y c h o l o g i s t s a n d f i n a n c i a la d v i s e r s .I n v es to r s s t i l l mak e th e k in d s o f mis -t a k e s t h a t h a v e g o t t e n t h e m i n t r o u b l e f o rd e c a d e s . T h e y a r e w o o e d b y t h e h o t t e s tn e w t r e n d , t h e y w a n t t o f o l l o w t h e c r o w d c o n s e q u e n c e s b e d a m n e d a n d t h e y j u s tc a n ' t s e e m t o p a y e n o u g h a t t e n t i o n t o i m -p o r t a n t d e t a i l s , s u c h a s t h e s t e e p a n n u a lf e e s c h a r g e d b y m a n y m u t u a l f u n d s ." W h e n i t c o m e s t o m o n e y , w e a r e o p -e r a t in g as i f w e w er e in th e ju n g le , h av -i n g t o d e a l w i t h p r e d a t o r s l i k e t i g e r s , "s ay s Br ad K lo n tz , a c l in ica l p sy ch o lo -g i s t a n d a s s o c i a t e p r o f e s s o r o f f i n a n -c ia l p lan n in g a t K an sas S ta te U n iv er -s i ty . " W e h av e a cav e- man b r a in . "T h e r e a r e w a y s t o a v o i d t h e s et \ p i t f a l l s . I n v e s t o r s n e e d a h a r d a n d P f a s t p l a n o f t h e i r i n v e s t m e n t g o a l s ,^ t h e y n e e d t o f i n d a t r u s t e d a d v i s e r

o r f a m i l y m e m b e r t o h e l p w e e d t h r o u g h d e -c i s io n s an d th ey n eed to s to p p ay in g som u c h a t t e n t i o n t o t h e s h o r t - t e r m e v e n t st h a t d r i v e m e d i a c o v e r a g e .H er e a r e th e s ev en d ead ly s in s o f in v es t -in g , in n o p a r t i cu la r o r d e r , an d h o w to p r o -t e c t a g a i n s t t h e m .Lu s t : Ch as ing Recen t Pe r fo rm an ceT h e b e li e f i n v e s t o r s f e e l t h a t r e c e n t p e r -f o r m a n c e w i l l d i c t a t e f u t u r e p e r f o r m a n c e k n o w n as " r ecen cy b ias " in p sy ch o lo g y iso n e o f th e b ig g es t in v es to r p i t f a l l s , ex -p e r t s s a y ." P e o p l e t e n d t o b u y s o m e t h i n g Ath a t h as d o n e r ea l ly w e l l r ecen t ly , " Msay s Ter r a n ce O d ean , a p r o f es s o r o f mf in an ce a t th e H aa s S ch o o l o f Bu s i - Wn es s a t th e U n iv er s i ty o f Ca l i f o r n ia , ^B e r k e l e y . " T h e y c h a s e p e r f o r m a n c e . "In th e lea d-u p to th e f inancial Ac r i s i s, i n v e s t o r s d i v e d h e a d l o n g mi n t o r e a l - e s t a te i n v e s t m e n t s , c o n- / / A

v i n c e d t h a t r i s i n g h o u s i n g p r i c e s w o u l dn ev er f a l t e r .T h e l a t e s t e x a m p l e : g o l d . T h e c o m m o d -i t y w e n t o n a w i n n i n g s t r e a k e v e n b e f o r eth e f in an c ia l c r i s i s , an d in v es to r s p i led in .A b i g f a c t o r w a s t h e h e a v y p r o m i n e n c eg o l d s u d d e n l y r e c e i v e d a c r o s s t h e m e d i a o n c o m m e r c i a l s , i n f i n a n c i a l p u b l i c a t i o n s ,o n te lev i s i n sh o w s an d in b o o k s . M ar k

K I R S T E N G R I N DI t h as b ee n n ea r ly f iv e y ea r s s in ce th e

D e s p i t e t h e d o w n t u r n t h a t l e f t m a n y i n -

Poor TimingInvestors oftenperform worse than their ownmutual funds by movingmoney inandout in an attempt to time the market.Fund returns vs. investor returns in U.S. stock funds.j ^ l 27.3% F u n d returns Investor returns

16.7, i.4%

1YR. I 3 YR. I 5 YR. I 10YR. I 15YR.Note: Data are average annual returns throug h J uly 31 and don't indude exchange-traded funds.Source: Morningstar The Wall Street J ournal

7/30/2019 The Seven Deadly Sins of Investing

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THE WALL STREET JOURNAL. Weclnesday, Sep tem ber 4, 2013 11INDEPTH

Gold prices peaked In 2011 and are now tradlng about 26% below thelr record hlgh.

Berg, president of Timothy Financial Counsel,a fee-only f inancial advisory f irm in Wheaton ,111., says one o ther wise rational clien t w antedto mo v e h e r en t i r e p o r t f o l io in to g o ld a f te rr ead in g a b o o k w ar n in g o f an o th e r mar k e tc r ash .To combat th is behavior , f inancial adviserssay it is impor tant that investors s tudy h is tor-ical pr ices and performance of the latest pop-ular investments . Histor ical char ts , for exam-ple, will show the r ise and fall of anyin v es tmen t o v er t ime .Instead of looking jus t at pr ices over th epast few months or a couple of years , look atthe long- term history over per iods extendingb ack a t l eas t 1 0 y ea r san d so met im es m o r e .Gold , for example, had been increasing inpr ice s ince 2001, but over the longer term hastrailed s tocks and barely kept pace with inf la-t io n .Despite the multiyear f renzy, gold pr icespeaked in 2011 and are now trading about 26%b elo w th e i r r eco r d h ig h .Similar ly , investor re turns of te n lag behindthose of the mutual funds they invest in , s inceman y p eo p le b u y f u n d s o n ly a f te r th e i r p e r -f o r man ce b eg in s to o v er h ea t , th en s e l l a f te rthe funds drop . As a result , the typical fundinvestor misses o ut on ear ly gains and locks inthe later losses ending up falling behind thefund itself .The average annual return for U.S. s tockmu tu a l f u n d s o v er th e p as t 1 5 y ea r s w a s6 .6%while the average investor in thosef u n d s ea r n ed ju s t 4 .6 %, acco rd in g to in v es t -men t r e sea r ch f i r m M o r n in g s ta r .While i t is easier said than done, investorshave to try not to pay atten tion to daily newsr ep o r t s an d ad v er t i s emen ts to u t in g th e la te s tp o p u la r in v es tmen t .Pride: Being OverconfidentEric Glohr , 54 years o d , new to investingat the time, p lanned to buy Microsof t s tock atits 1986 in itial public offer ing at $21 a shareless th an a d ime in sp l i t - ad ju s ted te r ms , ac -cording to FactSet. But on the f irs t day oftrading , the share pr ice shot up to more than$27, s ti l l less than a d ime in sp lit-ad justedt e r m s .Mr. Glohr decided to wait until i t sanklower again . He wai ted for years as the s tockmar ch ed h ig h er u n t i l h e f in a l ly r ea l ized i twould never d ip to the lower pr ice he had an-t ic ip a ted .I ts peak pr ice, in sp lit-ad justed terms, was$59.56 a share on Dec. 27 ,1999, according toF ac tS e t ." I w as w o r r ie d ab o u t a co u p le h u n d r eddollars and I missed out on cise to a milliondollars ," he says.Investors , especially ones new to the game,f r eq u en t ly b e l iev e th ey k n o w f a r mo r e th anth ey ac tu a l ly d o ab o u t a p a r t icu la r in v es t -ment, say psychologists a nd f inancial advisers ."Our opin ion of ourselves is much toohigh," says Mr. Odean, the f inance professor ."We all need a healthy dose of self -doubt andhumility ."Th e b es t w ay f o r in v es to r s to k eep th e i roverconf idence in check is to make sure theyhave an unbiased th ird par ly availab le lo goover all investing ideas. That could be a f inan-cial adviser , or i t could be a trusted cisef r ien d o r r e la t iv e w h o i sn ' t d i r ec t ly a f f ec tedby any decis in .Mr. Glohr , for h is par t , says he learnedf r o m h is ea r ly mis tak e . Ra th e r th an t r u s t h i sin s t in c t s en t i r e ly , h e jo in ed an in v e s tmen tclub and now diligently researches each com-pany in which he chooses to invest, bouncing

ideas off the members of h is group.Sloth: Overlooking CostsI n v es to r s o f ten ju s t d o n ' t p ay a t ten t io n todetails . Consider their wiUingness to invest inex p en s iv e mu tu a l f u n d s th a t d o n ' t p e r f o r mwell, says James Choi, an associate professorof f inance at Yale School of Management.I n v es to r s , w o o ed b y a f u n d man ag er ' sam e or rece nt perform ance , fail to look at af u n d ' s ex p en se r a t io b e f o r e b u y in g in . R a th e rth an b u y a ch eap in d ex f u n d th a t mimics abroad m arket index, such as the S&P 500, withan expense ratio of as l i t t le as 0 .05%, inves-to r s w i l l b u y o n e man ag ed b y a p r o f es s io n a ls to ck p ick er th a t ch a r g es a mu ch h ig h er f ee ,Mr. Choi says.Bu t mo r e ex p en s iv e f u n d s ten d to u n d er -perform less expensive ones, says Mr. Choi,c i t in g n u mer o u s s tu d ies .I t is the same with 401(k) fees . Investorso f ten w o n ' t p ay a t ten t io n to th e i r s ta tem en tseven though taking an active ro le in choosingth e i r in v es tmen ts w o u ld l ik e ly s av e th emthousands of dollars in the long run , say ex-p er t s .While a 401(k) investor doesn 't hold muchsway over the administration fees charged bythe provideror even th e choice of providerthere are ways to manage costs , say f inancialadvisers . Of ten 401(k) p lans will g ive investorsa choice of funds in cer tain asset classes , withexpense ratios that vary . Mr. Choi recom-men d s ch o o s in g th e ch eap es t o p t io n ."The expenses are much more predictive off u tu r e p e r f o r man ce b ecau se th e r e ' s so mu chr an d o mn ess in p as t p e r f o r man ce , " h e s ay s .Envy: Wanting to Join the Club

W h at i s b e t te r th an a g r ea t d ea l? A g r ea tdeal availab le only to you.In the r im-up to Facebook 's in itial publicoffer i ng in May 2012, f inancial advi sers sayth ey w er e s lammed w i th ca l i s f r o m c l ien tswho wanted to get in on the s tock before itmad e i t s d eb u t . Th e f ac t th a t th e r e w er e alimited number of shares available to retail in-vestors only drove the f renzy, advisers say .I t i s th e s ame r easo n in v es to r s w er e sowilling to believe in Bernard Madoff 's Ponzischeme, exper ts say . They were par t of a smallgroup making a lo t of money; Mr. Madoff re-

p o r ted ly accep ted o n ly a l im i ted n u mb er o fclien ts ."A lo t of tha t has to do with th at sen se ofexclusivity," says Meir Statman, a professor off inance at Santa Clara University who focuseson behavioral f inance.The desire to be p ar t of an exclusive offer -ing of ten dr ives people to throw money in toan investment that doesn 't f i t in to the overallg o a ls o f th e i r p o r t f o l io , ag a in s t th e i r b e t te rju d g men t . I n v es to r s w h o p o u r ed mo n ey in toFacebook just af ter i ts launch watched as thecompany 's s tock fell below $20 a sha re severalmonths later , far less than its $38 IPO pr ice.(The s tock is now trading at about $41.)Susan Strasbaugh, owner of Strasbaugh Fi-nancial Advisory in Colorado Spr ings, Colo . ,w h ich h as $ 1 0 0 mi l l io n in a s se t s u n d er man -ag emen t , s ay s sh e r eco mmen d s c l ien ts s e t u pa separate "Vegas" account for hot invest-ments l ike Facebook that don 't f i t in to a cli-en t ' s p o r t f o l io .S h e s ay s c l ien ts sh o u ld in v es t n o mo r ethan 5% of their por tfo lio in the Vegas ac-count, and treat i t l ike gamblinghenee the a m e .Wrath: Failing to Admit FailurePeople hate to lose money. Along with herinvesting club , Lor i Towers-Hoover , 54 ,b o u g h t sh a r es o f h o me b u i ld e r M e r i tag eHomes at about $32 a share in 2007. Ms. Tow-ers-Hoover and her club in Howell, Mich., hadth o r o u g h ly r esea r ch ed th e co mp an y an d b e -lieved in its strong financiis. But the stock al-ready was on its way down, and by ear ly2009, i t was trad ing at less than $10 a share.Ms. Towers-Hoover and her club hung on .Th ey w a i ted f o r an o th e r y ea r a s th e s to ckhovered aro imd $20. Finally they so ld . "Wejust made the decis in it 's not going to re-b o u n d an d w e ' r e n o t g o in g to g e t o u r mo n eyback," she says.Loss aversin , as i t is called by psycholo-gis ts , isn ' t hard to spot. Investors held on totech s to ck s as th ey p lu mmeted d u r in g th ecrash of the ear ly 2000s, as they d id to f inan-cial s tocks dur ing the cr is is , and as they con-t in u to w an t to d o to d ay ." W e d o n ' t w an t to b e h o n es t w i th o u r -selves and admit the loss ," says Mr. Klontz,th e p sy ch o lo g is t .

That type of th inking can be dangerous forinvestors . I f they regret a decis in , they maysell too soon, but if they can 't accept theirloss and move beyond the "sunk costs" of aninvestment, they may hold on too long, sayp sy ch o lo g is t s .Instead of just researching the f inanciis ofa p a r t icu la r s to ck , in v es to r s n eed to u n d er -s tan d th e eco n o mic en v i r o n men t a s mu ch aspossib le, say f inancial advisers and e xper ts . I fa co mp an y i s d ep en d en t o n a jo b - mar k e t o rhousing-market recovery to perform well, in-v es to r s n e ed to f u l ly u n d er s ta n d th e o u t lo o kf o r th o se s ec to r s an d p lan th e i r in v es tmen taccordingly . Too of ten investors will basetheir decis in to buy or sell so lely on thes t r en g th o f a co mp an y .Of course, economic predictions aren 't al-ways correct. Ms. Towers-Hoover says herclub 's decis in to sell Meritage was based onp r ed ic t io n s th a t th e U .S. w o u ld n ' t f u l ly r e -cover from the 2008 dowMurn until 2016. But,buoyed by a housing-market recovery , Meri-tage s tock began to r ise in mid-2011 and ist r ad in g a r o u n d $ 4 0 a sh a r e n o w .That s tock 's recent tear taught Ms. Tow-ers-Hoover another lesson: I t is impossib le tot ime th e mar k e t .Gluttony: Living for TodayLet's face it : There are a host of activ itiesmo r e in te r es t in g th an mo n i to r in g y o u r4 0 1 ( k ) an d a h o s t o f t emp ta t io n s to sp en dmoney on today. But investors ' tendeney to-ward apathy is damaging, par ticu lar ly when itco mes to r e t i r emen t s av in g s .Fif ty-sev en percen t of U.S. work ers sur-veyed by the Em ployee Benef it Research Insti-tu te ea r l ie r th i s y ea r r ep o r ted le s s th an$25,000 in to tal household savings and invest-men ts , n o t co u n t in g th e i r h o u se o r d e f in ed -b en ef i t r e t i r emen t p lan s . Th e lack o f p r e -p a r ed n es s h as led ex p er t s to d eem i t a c r i s i s .O f ten w o r k er s a r en ' t s av in g ea r ly en o u g hb ecau se th ey v iew r e t i r emen t a s a f a r - o f fev en t , l ead in g to ap a th y to w ar d p u t t in gmoney away, say f inancial advisers and psy-chologists .The key for investors , Mr. Klontz says, ismak in g r e t i r emen t le s s ab s t r ac t . I n v es to r sshould ask themselves a ser ies of questionsab o u t h o w th ey w an t th e i r l i f e s ty le to b ewhen th ey retire: How od will they be? Wh erewill they live? What will they be doing?Mr. Klontz also uses a measur ing tape tomak e th i s p o in t , mar k in g i t a t an in v es to r ' sage and then again at the age an investor ex-peets to l ive until , based on the longevity ofo th e r f ami ly memb er s . W h en an in v es to r i slooking at a length of tape that is only, say, 20or 30 years long, that can be a s tark realiza-tion of the lack of t ime he has lef t to save.Often , Mr. Klontz says, th is encoura ges in-vestors to add more to their 401(k) contr ibu-t io n s o r r a tch e t b ack sp en d in g .Greed: Following the HerdW h en th e s to ck mar k e t t an k ed d u r in g th e2 0 0 8 f in an c ia l c r i s i s , man y in v es to r s f led ,so me ab an d o n in g th e i r en t i r e p o r t f o l io s an dp u t t in g th e mo n ey in to cash . Th e s ame p h e-nomenon is happening now in li te bond mar-ket as investors , worr ied about the ef fect ofr i s in g in te r es t r a te s , a r e f lee in g b o n d f u n d s .Investors yanked $11.7 b ill ion f rom thefunds in Ju ly , according to Morningstar , fo l-lowing an outf low of $60 b ill ion in June. Asinvestors pul money, i t encourages more in-v es to r s to d o th e s ame .To b a t t le th e f ea r th a t in ev i tab ly co meswith a market decline or o ther adverse events ,f inancial advisers say it is crucial that inves-to r s h av e a d e ta i led p o r t f o l io p lan th a t th eys t ick w i th r eg ar d les s o f sh o r t - te r m ev en ts .Th e p lan sh o u ld o u t l in e in v es to r s ' t a r g e tedhold ings in bonds, s tocks and o ther invest-ments , and be based on their retirement goals ."Right now, bonds are bad in the minds ofinvestors ," says Chad Car lson , a wealth man-ager at Balasa Dinverno Foltz in Itasca, 111.,which has $2 .6 b ill ion in assets under man-agement. "Our clien ts will say , ' I want to beout of bon ds entirely . '"Ra th e r th an en co u r ag in g an " a l l o r n o th -in g " ap p r o ach , M r . Car l son r eco mm en d s th a tin v es to r s ad ju s t th e i r p o r t f o l io a smal lamount. For example, a clien t who previouslyheld 40% of h is por tfo lio in bonds would re-d u ce th a t ex p o su r e b y s ev er a l p e r cen tag ep o in ts .That move tends to reassure investors andhelps them avoid rash decis ions, he says.ehman Brothers flled for bankruptcy protectlon on Sept. 15,2008. What have Investors learned since then?