Ninety percent (90%) of investor gains or losses over your lifetime will come from education and mindset. It’s not about learning to be a good investor. 90% of these gains or losses come from learning how not to be a bad investor. And it comes down to just 6 mistakes.
I’ve recently finished reading a great book on investing called Simple Wealth, Inevitable Wealth, by Nick Murray. This is the revised third edition and is from 2008.
In this blog, I summarized the most important points for you.
A Grain of Salt
Now, I don’t agree with everything in the book.
For one, I am a Bitcoin bull and crypto investor (and yes, I do see those as two separate things). This book was written before Bitcoin, and covers investing in stock market funds. However, some of these principles apply across asset classes.
He also stresses the importance of hiring a financial advisor. The biggest reason he gives for this is so they can hold your hand and tell you not to sell when the market crashes. I agree with this value proposition in general, though it’s not for me. I believe education and a system can fix this.
He listed eight investor mistakes, and I have chosen six that I vibe with. If you want to get the data from the source, you can order the book here.
It’s All in Your Head
That being said, this book covers the mindset. S&P 500 gains from 1926 to 2006 (it’s actually more since) were 10% per year. However, due to these common mistakes investors in these funds made far less.
Why? Because of the 6 biggest mistakes investors make.
1. Over Diversify
If you are investing in more than 5 or 10 areas, you are not diversifying, you are shopping.
In stocks, this could mean investing in a dozen different funds and adding another one every time an analyst mentions one.
2. Under Diversify
The most obvious way this happens is by putting all your investment in one asset. However, this can be misleading.
If you invest in 8 different chip stocks, that is not diversification, because a shift in the market will affect all of them.
If you invest in 20 different small cap crypto currencies, odds are 19 or 20 of them will crash in a market crash. If one of them outperforms, it won’t really help. Due to the fact that the market is deeply tied to Bitcoin, diversification is very ineffective in crypto as of yet.
If you put 90% of your investments in one asset, having 5 other funds doesn’t matter.
The suggested diversification for 5 types of ETFs that Murray recommends and makes sense to me is:
- Large Cap
- Small Cap
- Growth Stocks
- Income Stocks
- International
3. Hype
This is also known as Euphoria, FOMO and overconfidence.
Or as I like to say, Einstein’s Theory of Relativity requoted:
The higher an asset price rises, investors’ perception of risk approaches zero. In truth, the longer a bull market has continued, the more likely it is to end. The best antidote for a long-term investor through dollar cost average investing.
4. Fear
This is the opposite of but equally disastrous to hype. This is also known as FUD, panic selling, or volatility.
This is the main reason investor’s gains are not the same as the gains of the investment they invested in. They sell because of fear.
Bitcoin might be up 22,120% over the past 9 years, when it was $108 on July 29, 2013. A single investment of $1,000 would be worth over $221 million. However, the majority of those who invested (or mined) $1,000 of bitcoin sold it between then and now. There have been at least eight drops of 50% or more since then.
In a more traditional realm, the S&P 500 has grown more than 10% every year since 2009. However, it has had 3 negative years, including so far this year. Many investors sell at the market bottoms, thus losing out on the gains of holding long-term.
As a note, many penny stocks, and most speculative cryptocurrencies do in fact crash and do not recover. I am thus deliberately only referring to Bitcoin in my example of a cryptocurrency, which is the least volatile in a very volatile asset class.
5. Crossing the Line between Investing and Gambling
This is often combined with hype (above) and overleveraging below. One can tend to get too emotionally attached to items in their portfolio, or to get too focused on winning back recent losses.
Borrowing to either invest in stocks or crypto is an example of this. Selling everything and putting it into one asset is a great example. Not sleeping and staring at the crypto charts or staring at stock charts all day is a sign that one is involved in gambling.
The point of learning these mistakes is to increase the odds of certainty, so you can sleep better at night. You could win at gambling, but the odds are not in your favor.
6. Overleveraging
Better safe than sorry.
Very recently, this was criminally abused in the crypto sector by institutions and was also done by hedge funds in the stock market. This is gambling or speculating, not investing.
3AC, Celsius, Voyager, etc. have filed bankruptcy because they took gambling to an institutional level. Hedge fund manager Bill Hwang lost $20 billion in two days in 2021.
As an individual investor, the goal is to sleep well at night and secure your future. Thus, the less leverage the better. Here are some tips to follow if you want peace of mind.
- Pay down high interest debt first before investing.
- It’s one thing to have a 30-year mortgage and pay it down long-term. Investing in renovations to then resell or setting up a real estate property that produces income makes sense. It’s completely another to take out a loan to trade or invest in crypto or stocks. This is speculating, not investing. You want less leverage, not more.
- Do not leverage trade stocks or crypto if you are an investor. A professional trader is one thing, do not mix the two. If you have a monthly “gambling in Vegas” budget, feel free to spend it here and not a penny more. Expect to lose 100%.
Summary
These six tips lose investors a lot of money. If you avoid them you could potentially outperform 90% of retail inventors. Follow them and improve your odds of success.
The book also stresses dollar cost averaging monthly which I am a strong believer in.