Navigating the Investment Minefield

A Practical Guide to Avoiding Mistakes, Biases, and Traps

H. Kent Baker, Vesa Puttonen

• Publisher: Emerald Publishing Limited
• Year: 2019
• Print ISBN: 9781787690561
• eBook ISBN: 9781787690554
• Topic: Business
• Subtopic: Accounting
• Index: Business

When you think about investing, what words come to mind? Overwhelming? Intimidating? Scary? 

Investors face a vast array of investment options vying for their business. They are aware that some of those providing these "opportunities" seek to take advantage of them. And although most investors realize they are fallible, they often have no clear idea why or what they can do about it. So what chance do less savvy investors have navigating the investment minefield and emerging unscathed? 

The answer is not much-unless they recognize the pitfalls along the way. In this book, H. Kent Baker and Vesa Puttonen show new investors how to avoid rash financial decisions and basic investing sins. They help them to recognize and avoid common investing mistakes, behavioral biases, and traps that can affect sound judgment and reduce wealth. Ultimately, they explain how to separate investment fads from time-tested investment principles-a task that is easier said than done, but that is well worth the effort.  

Navigating the Investment Minefield is essential reading for novice investors, and it is of keen interest to more seasoned investors seeking a refresher course on the most basic, time-honored truths of wealth management.

CHAPTER 1

NAVIGATING THE INVESTMENT MINEFIELD: DON’T BE INTIMIDATED BY THE WORLD OF INVESTING

We don’t have to be smarter than the rest. We have to be more disciplined than the rest.

Warren Buffett (American Business Magnate, Investor, and Philanthropist)

When you think about investing, what words come to mind? If you’re like most investors, these words are likely to be overwhelming, intimidating, and scary. To many people investing is a four-letter word because they think they’ll be overwhelmed by financial jargon and hours of tedious research. They remember that during the past decade, investors faced many challenges including the subprime mortgage crisis, a deep recession, a slow economic recovery, wars, terrorism, and much more. Investors also face a vast array of investment options with many vying for their business. They are aware that some of those providing these “opportunities” seek to take advantage of them. Although most investors realize they are fallible, they often have no clear idea why or what they can do about it. No wonder people often view investing as overwhelming, intimidating, and scary especially if they attempt to tackle this task on their own. Although most individual investors aren’t experts, they still must take responsibility for their actions and financial lives. To be financially successful, you must avoid many pitfalls along the way or risk-making errors that affect your wealth.

Given the complex and challenging world of investing, what chance do less-savvy investors have navigating the investment minefield and emerging unscathed? The answer isn’t much, unless they recognize the pitfalls along the way and deliberately sidestep these financial landmines. Investors need to avoid making rash financial decisions and committing investing sins. They also need to separate investment fads from time-tested investment principles. Accomplishing this task is easier said than done but it’s worth the effort.

Investors face three major challenges: (1) making mistakes, (2) displaying behavioral biases, and (3) falling victim to investment traps because they lack the knowledge, experience, or self-discipline to make better choices. Making mistakes is part of investing, especially for novice investors. As Irish poet and playwright Oscar Wilde once noted, “Experience is simply the name we give our mistakes.” Although you can’t travel back in time to fix your mistakes, you can learn from and avoid repeating them. Thus, mistakes provide the stepping stones to learning.

People can also be their own worst enemies. They suffer from many behavioral or psychological biases that affect their judgment and decision-making. A bias is nothing more than the predisposition toward error. Thus, a bias is a prejudice or a propensity to make decisions while already being influenced by an underlying belief.

Investors can also fall into investment traps. In the world of investments, an investment trap is something that can lead to losses of capital or opportunities to make productive investments. Although succumbing to such traps is unlikely to be fatal, it can seriously harm your personal wealth, affect achieving financial goals, and damage self-esteem.

Investors may be unaware of why they make the investment decisions that they do. Poor decisions can result from bad advice, the wrong advisor, or decision methodology. Many beginning investors also devote little attention to understand investing and the choices available to them. They may even spend less time managing their portfolios than planning a vacation or buying a car!

Making sound investment decisions is part of being financially literate. Financial literacy is the ability to understand how money works in the world: how people earn or make it, how they manage it, and how they invest it to create more wealth. Financial literacy also refers to the set of skills and knowledge that allows people to make informed and effective decisions and utilize all of their financial resources. Financial literacy should command attention because many people are inadequately organizing their finances to ensure their own well-being. A lack of financial literacy costs people tens of billions of dollars every year.

Financial illiteracy is like being in a rain storm and trying to jump in between the raindrops [...] eventually it all catches you at the same time.

Johnnie Dent, Jr.

Becoming financially literate typically requires many hours of study and effort generally achieved over a long period. Although becoming financially fit may seem daunting, it isn’t a pipe dream, as long as you’re willing to seek some assistance. Although even knowledgeable investors make mistakes, let psychological biases affect their decisions, and tumble into investment traps, they do so far less often than less-savvy investors. Those investors with less know-how need to sharpen their financial saw.

WHERE TO BEGIN

Investors sometimes find themselves in a similar position as Alice from Lewis Carroll’s Alice’s Adventures in Wonderland. Coming to a fork in the road, she asks the Cheshire cat:

Alice: Would you tell me, please, which way I ought to go from here?

Cheshire cat: That depends a good deal on where you want to get to.

Alice: I don’t much care where.

Cheshire cat: Then it doesn’t matter which way you go.

Alice: So long as I get somewhere

Cheshire cat: Oh, you’re sure to do that, if only you walk long enough.

The moral of this story is to start at the beginning – knowing which way to go. As Yogi Berra, the famous New York Yankee and member of the Baseball Hall of Fame, once said: “You’ve got to be careful if you don’t know where you’re going, ’cause you might not get there.” Unlike Alice, investors should base their investment decisions on clear goals and then determine the appropriate path for achieving them. Unfortunately, many investors get caught up in the latest investment fad or focus on short-term investment returns instead of following a plan designed to help them achieve their long-term goals.

A goal without a plan is just a wish.

Antoine de Saint-Exupery

Investors can follow several paths to achieve their financial goals. One path is to “go it alone.” If you’re intent on managing your investments, you want to be sure that you’re qualified to do so. Another path is to use the services of a qualified professional. Working with a financial advisor and knowing how to do your own financial planning aren’t mutually exclusive. Even if you decide to use the services of a financial advisor, you should have at least a basic knowledge about personal finance, especially investing, so that you understand the advice you’re receiving and know what questions to ask. Just because you work with an advisor doesn’t mean that you can abdicate your own responsibility. A third option is to use a robo-advisor. These new digital platforms can manage a portfolio for only a fraction of the cost of a human financial advisor but involve several drawbacks.

The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.

Benjamin Graham

Regardless of which path you take, the process begins by establishing your financial goals. In general, the basic goal of investing is to build wealth. Once you’re wealthy, you need to retain your wealth. Being “wealthy” differs from person to person and depends largely on your state of mind and lifestyle. Perhaps, being wealthy means having no financial constraints on activities, surpassing a certain asset threshold, or not having to work again. Whatever your definition, building wealth is a key goal.

BEING A DO-IT-YOURSELFER

Taking a do-it-yourself (DIY) or self-directed approach entails managing your own money, including your investments. For most, planning their financial well-being including retirement has become a DIY proposition. Why? People typically don’t work for organizations that offer much in the way of financial or investment advice. Hence, you need to develop competency in personal finance. Even if you work for an organization that provides a retirement plan, the financial landscape has shifted away from defined benefit pension plans to defined contributions plans, which are now the dominant plan form in the private sector. With a defined benefit pension plan, an employer promises a specified monthly benefit on retirement that is predetermined by a formula based on the employee’s earnings history, tenure of service, and age. The employer bears the risk of providing these fixed payments. By contrast, in a defined contribution plan, employers and employees make fixed contributions into an individual account, which are then invested. The employee determines where to invest these funds and hence assumes the investment risks and rewards, not the employer. Thus, knowing how to do your own financial planning and investing is more important than ever.

It takes half your life before you discover life is a do-it-yourself project.

Napoleon Hill

Well-informed individual investors can often do quite well on their own, especially if they have a carefully crafted investment plan and diligently execute it. Unfortunately, many people unwittingly sabotage their chances of meeting their financial goals by violating the terms of prudent investment plans. On their own, novice investors tend to underperform the markets in which they invest. A DIY approach can be fraught with danger if you lack the specialized knowledge and discipline necessary to succeed in today’s highly competitive financial markets. Emotions play a big role because DIY investors often do exactly the opposite of what they should. For instance, investors might attempt to “time” market movements, engage in inadequate diversification, pay high and unnecessary fees to managers and advisors, and use borrowed money in an attempt to gain higher returns.

Yet, despite numerous pitfalls, you can avoid or at least reduce making common investing mistakes and succumbing to behavioral biases. You can also avoid being duped into investment traps by becoming more informed about financial matters in general and investing in particular. One of the biggest risks you face is failing to educate yourself about which investments can help you achieve your financial goals and how to approach the investing process. As Benjamin Franklin once said, “An investment in knowledge pays the best interest.” Warren Buffett echoes this sentiment when he remarked, “The most important investment you can make is in yourself.”

Nothing is more likely to pay off than gaining financial education and engaging in the necessary research, study, and analysis before making investment decisions. As Peter Lynch, the former manager of Fidelity Magellan Fund, notes, “Average investors can become experts in their own field and can pick winning stocks as effectively as Wall Street professionals by doing just a little research.” A lack of knowledge and awareness could result in regrettable financial decisions that diminish your wealth. If you aren’t an informed or intelligent investor, others can and will take advantage of you. If you don’t believe this statement, just ask the person with a “this can’t happen to me attitude,” who has fallen victim to investment fraud.

Invest in yourself. Your career is the engine of your wealth.

Paul Clitheroe

Don’t underestimate your abilities or potential or cut corners when learning how to become a successful investor. You need to learn basic principles before investing. With sufficient time devoted to learning and research, you can become equipped to handle your own portfolio and investing decisions. As H. W. Lewis writes in his book Technological Risk, “Those who are unwilling to invest in the future haven’t earned one.” In fact, you might be better off being a DIY investor, even if you currently lack competency, than working with an incompetent or conflicted advisor. Much of investing involves applying common sense and not being swayed by emotions. Billionaire investor Warren Buffet once observed that “You don’t need to be a rocket scientist. Investing isn’t a game where the guy with the 160 IQ beats the guy with 130 IQ.” He also stated that “You don’t need extraordinary intelligence to succeed as an investor.”

WORKING WITH AN ADVISOR

Another path to helping you achieve your financial goals is to use the services of a qualified professional such as a financial planner, an investment advisor, or a wealth or money manager who has the requisite knowledge, skills, and abilities. Although differences exist among these individuals, we’ll simply call them financial advisors. Unfortunately, much confusion exists over the term “financial advisor.” In fact, no professional designation called financial advisor exists. However, when choosing a financial advisor, you should focus on selecting someone who has earned such respected designations a Chartered Financial Planner (CFP), Chartered Financial Consultant (ChFC), Certified Public Accountant/Personal Planning Specialist (CPA/PFS), or Chartered Financial Analyst (CFA). Whether you should hire an investment advisor to manage your investments is a complex question that requires careful consideration before deciding. You don’t have to be a financial lightweight to need a financial advisor, as almost anyone can benefit by hiring the right financial advisor. As Warren Buffett notes, “It is better to hang out with people better than you. Pick out associates whose behavior is better than yours and you will drift in that direction.” For example, these professionals can help clients: (1) set reasonable financial and personal goals, (2) assess their current financial health, (3) develop a realistic, comprehensive plan to meet their financial goals, (4) put their plan into action and monitor its progress, and (5) help them stay on track to meet changing goals, personal circumstances, markets, and tax laws. Those who have a financial plan generally feel more confident and report more success managing money, savings, and investments than those who don’t have a plan.

Financial advisors often take a holistic view of their clients’ financial needs and goals, meaning they look at the big picture. They can add value both by potentially improving investment performance and by mitigating psychological costs, such as reducing anxiety. Clients can also benefit from their relationship with the advisor, specifically through financial planning and advice on savings and asset allocation. In fact, the true value of a financial advisor often lies in managing the investor rather than the investments.

Most people don’t plan to fail, they fail to plan.

John L. Beckley

Some financial advisors focus on offering investment advice to individuals. They counsel clients on investment opportunities that are consistent with the client’s needs, goals, and risk tolerance. This approach requires keeping in touch with the financial markets, constantly monitoring the specific investments in a client’s portfolio, and being aware of new investment strategies and investment vehicles. However, finding and hiring an expert advisor can be a complicated financial decision, especially if you have limited expertise. Also, some financial advisors aren’t investment experts and can’t render good advice due to conflicts of interest.

The more your money works for you, the less you have to work for money.

Idowu Koyenikan

WHO NEEDS A FINANCIAL ADVISOR?

Before explaining how to find the right financial advisor, let’s discuss why you might need one. Although everyone has to make decisions about managing money, you might lack the expertise, time, or desire to actively plan and manage certain financial aspects of your life. If you have wobbly emotions, you probably shouldn’t be steering your own financial future. Don’t be afraid to ask for help. You shouldn’t wait for a crisis or moment of desperation to hire an advisor. As former President John F. Kennedy once remarked, “The time to repair a roof is when the sun is shining.”

Planning is bringing the future into the present so that you can do something about it now.

Alan Lakein

Financial advisors can often provide personalized advice on your entire financial situation, from your insurance coverage and spending habits to sa...

Table of contents

• Cover
• Title Page
• Chapter 1 Navigating the Investment Minefield: Don’t Be Intimidated by the World of Investing
• Chapter 2 Avoiding Common Investing Mistakes: Don’t Make the Same Mistake Twice
• Chapter 3 Overcoming Your Behavioral Biases: Don’t Be Your Own Worst Enemy
• Chapter 4 Trap 1: Overpaying for Products and Services
• Chapter 5 Trap 2: Becoming a Victim of Investment Frauds and Scams
• Chapter 6 Trap 3: Misrepresenting Risky Products as Safe
• Chapter 7 Trap 4: Investing in Complex Products
• Chapter 8 Trap 5: Relying on Unsupported Evidence
• Chapter 9 Trap 6: Having Unrealistic Return Expectations
• Chapter 10 Trap 7: Engaging in Gambling Disguised as Investing
• Chapter 11 Trap 8: Falling for Mutual Fund Traps
• Index