From Daniel Chancellor and Gerd Kommer
Investment books, print articles, blog posts, podcasts and YouTube videos with titles like “The Ten Biggest Investor Mistakes” or “The 20 Worst Investing Mistakes” abound. Before writing this blog post, we asked ourselves whether we should actually add another publication to this mountain of publications.
The answer: Yes, such investor error publications are a dime a dozen, but the problem they address is omnipresent and is in fact very important for the success or failure of private investors. Those who do not make the most serious investor mistakes or make them less frequently increase the chance of reaching or exceeding their personal target wealth by the age of 30, 50 or 70. Conversely, those who make these mistakes unnecessarily often increase the likelihood of failure at these goals.
Before we present what we believe to be ten particularly serious “investor sins”, it should be noted that these top ten represent a subjective selection. You could just as easily list 50 or 100 common errors and it would still be incomplete. In particular, in this article we will not explain some equally important errors that have already been discussed elsewhere, such as: B. tolerating high costs or the so-called Home bias.
Investor Mistake 1: Not actively managing the most profitable of all asset classes
Neither stocks, nor real estate, nor cryptocurrencies, nor gold is the most profitable of all asset classes, but rather human capital. Human capital is the “present value” (value in today's money) of all future net income of a household or person that has not yet been collected at a certain point in time. The American Gary Becker received the Nobel Prize in Economics in 1992 for his research on the human capital concept. Statistically speaking, no single influencing factor moves the final wealth of a person or household at the age of 50, 60 or 70 more than the level and development of human capital.
The human capital of a 25-year-old university graduate in Germany is around two million euros in today's money if he works until 65, chooses an average marketable field of study and has a completely normal employment history in this category. If he works five years longer, his HK will increase by around 350,000 euros in today's money and will decrease by around this amount if he retires five years earlier. For someone without a degree but with a sought-after craft training, the numbers don't look much different.
How to manage and increase your HK? By acquiring a “skill set” (commonly known as training) that is economically attractive in the market, by continuously developing this skill set during your working life (educating yourself throughout your life), by not only “theoretically” but also actually trying to be professionally successful, i.e. “working hard” and/or being professionally committed, by living healthily (diet, exercise, little alcohol, no smoking, no other drugs) and, of course, by controlling the part of your existence that you are considered to be Couch potato waste on the Internet or on Netflix.
From a statistical perspective, entrepreneurial activity clearly brings the highest potential for increasing one's own human capital (see here), but even as an employee you can increase your human capital well beyond the two million euros mentioned at the beginning.
Investor Mistake 2: Not resolving conflicts of interest
“Don’t eliminate conflicts of interest” doesn’t exactly sound like a spectacular money mistake, the correction of which will boost your returns on a large scale from the following month onwards or significantly reduce your risk. Nevertheless, we believe that over the long term, eliminating existing or avoiding new conflicts of interest makes more direct and indirect difference to success in wealth creation and risk reduction than any other conceivable investor mistake, with the possible exception of Mistake #1 highlighted above.
In German-speaking countries, conflicts of interest are almost guaranteed in 99% of all banks and in 90% of all “bank-independent” financial advisors and asset managers. They arise from the fact that the service provider sells or brokers in-house products, collects commissions and commissions from third-party product providers, and takes performance-dependent fees (see also here) and that overall his remuneration is not completely independent of his client's type of investing - i.e. regardless of whether the client is conservative or "ambitious", whether he trades a lot or little, whether he invests in asset class A or B or whether he invests in financial product X or Y.
You can cure the plague of conflicts of interest in two ways: either by organizing your investments completely yourself or by hiring a service provider whose payment is made 100% in cash by you, just as you would pay a tax advisor, lawyer or craftsman. (As mentioned, performance fees are taboo.)
Investor Mistake 3: Consuming too much “investment pornography.”
Investment and financial pornography is a very large part, perhaps even the majority, of what is published in traditional media, by financial companies and on the Internet about investing, wealth creation and retirement planning. In particular, this includes statements and implicit promises to get “rich” with little or limited risk.
A mild form of investment pornography is, for example, an advice book title like “Get Rich on the Stock Exchange” (Thilo Hasler); a medium form of investment porn is the cover of an investor magazine that says in bold, screaming letters “Killer stocks!” (Der Aktionär 05/2015), a violent form of investment porn is an article in the online edition of a large German daily newspaper with the headline “You can only win with these 10 stocks” (Die Welt Online, November 16, 2019) or the advice book “Richer than the Geissens – Become a real estate millionaire in five years with zero euro starting capital” (author Alex Fischer).
Financial pornography appeals to some of the worst feelings and traits in Homo Sapiens: greed, FOMO (Fear of Missing Out), envy, gullibility, overconfidence, laziness or fear (during bad stock market times).
The species of “doomsday prophets”, which is very widespread in Germany and who see an apocalyptic crash in banks, stocks, bonds and real estate coming in the “near future”, typically belongs to the hard core category of the P-topic.
Private investors who consume too much salacious financial pornography are likely to damage their long-term financial health and are even more likely to damage their peace of mind. Such an investor is placed in wrong, i.e. h. Investing in financial products that are too expensive or too risky, he will spend too long on the sidelines of the investment playing field and he will buy or sell at inopportune times more often than necessary.
Investor Mistake 4: Overconfidence Bias/Lack of Humility: Believing that you are largely immune to other people's investor mistakes
The overconfidence bias (to put it bluntly, the lack of humility) is a common investor mistake with high potential for damage. It is the overconfidence in one's own investment skills that is not justified by the actual results achieved in the long term. It's fake self-confidence without humility, with too little rationality and too little honest learning from your own mistakes. When investing, the overconfidence bias is easily evident in the mistaken belief that one can relatively reliably predict future returns on certain listed investments, real estate investments, cryptos or collector's items (e.g. luxury watches, vintage cars, art, etc.) in the near future. Statistically, men suffer more from the cognitive and moral weakness of overconfidence bias than women. The overconfidence bias in relation to investments tends to be further reinforced by studying economics or working as a managing director of a company.
Investor Mistake 5: Falling for the media nonsense of “now is the wrong time to get in” or “this time everything is different.”
The famous fund manager and financial entrepreneur John Templeton (1912 – 2008) once said “The four most dangerous words in investing are ‘This time, it’s different’”. There may be few quotes about investing that are truer and more helpful (if you put it into practice) than this one.
Market timing – trying to take advantage of particularly good and/or particularly bad market phases for an asset class in your own portfolio through “in/out” or “back and forth” – is statistically a losing strategy. Investing immediately in everything there is to invest in at any given time and then engaging in disciplined buy-and-hold yields statistically higher long-term returns. Sixty years of empirical financial market research leave virtually no doubt about this.
But that doesn't stop representatives of the financial industry, journalists and finfluencers from exploiting our harmful instincts by making us believe that a smart investor must wait for the "right" time or a "better" time to "enter the market". This waiting produces opportunity costs (lost profits) that usually outweigh the potential benefit of waiting. The aforementioned John Templeton knew this when, when asked by an investor when was the best time to invest the money she had just inherited in stocks, he simply replied: “The best time to invest is when you have money.” And here’s another famous quote from another legendarily successful fund manager, Peter Lynch (born 1944): “More people lose money waiting for market corrections and anticipating corrections than in the actual corrections.” [1]
If that still doesn't convince you: We have twice, in different ways, calculated how poorly "wait for the bargain season" or "buy the dip" works as an investment approach, based on long-term historical data here and here.
And we also know that an all-time high for stocks is an unwise reason to “wait now” or “sell now”. here shown.
Investor Mistake 6: Confusing risk that is invisible or difficult to measure with low risk
Financial products and asset classes can be divided into “risk-honest” and “risk-dishonest” products. Risk-honest investments show all of their risk completely openly, continuously and without delay. Risk-dishonest investments either do not show their risk openly or do not show it continuously or only with a time delay.
Listed securities are the most risk-taking investments.
Direct investments in real estate, open real estate funds and private equity investments can be assessed as “moderately risky”. [2] For example, the considerable fluctuations in the value of real estate cannot be observed on an ongoing basis and therefore appear to most private households to be moderate or even non-existent. A look at the stock market prices of real estate companies such as Vonovia SE illustrates how high these fluctuations actually are, especially in the equity share in a real estate investment.
We have found out why and how private equity and open-ended real estate funds are risk dishonest here and here shown in detail.
Bank deposits, capital-forming life insurance, private pension insurance, P2P loans, certificates and closed-end fund investments are maximally risk dishonest. Most of the default and volatility risks they contain are invisible to ordinary retail investors.
Example bank deposits: It has zero volatility (no fluctuation in value or returns) and therefore appears to many to be very safe and this is exactly how this financial product is marketed by banks. In reality, a bank balance above the statutory deposit guarantee of 100,000 euros per bank-customer combination conceals a considerable risk of default with up to 100% loss potential. In addition to this default risk, interest-bearing bank deposits are very risky in another way, like ours here have shown.
The fact that a risk is not open and easily visible does not mean that it does not exist. Anyone marketing risk-dishonest financial products or asset classes should point this out.
Investor Mistake 7: Falling for the Recency Bias and the Small Sample Bias
In our opinion, two of the most perfidious investor mistakes made by economics Behavioral Financeresearch revealed are the Recency Bias and the Small sample bias. These two common investor misconceptions are related. Small sample bias is a generalized form of recency bias.
Recency Bias stands for “tendency to overvalue the recent past” Small sample bias for “Tendency to infer the whole from small or unnecessarily small samples.” That's the general definition, but what is it specifically about?
Private investors base their investment decisions heavily on past returns. This in itself is not irrational and not fundamentally wrong. However, it is almost always wrong to take more recent historical returns more seriously than older, more distant data. To put it more concretely: the return of an MSCI World ETF, of gold, Bitcoin or the Infineon share in the last twelve months or five years is not fundamentally more important or representative for the future - and this is what investment decisions are about - than the twelve months of 2010 or the five years from 2013 to 2017. Nevertheless, private investors are downright obsessed with recent returns and make their investment decisions primarily on the basis of this current short-term data.
How can you avoid this dangerous mistake? Quite simply: by making your investment decisions based only on long data series. For the equities asset class, at least 25 years and ideally the longest data series available. For an actively managed equity fund, the entire period since its inception. For a single share, no period of less than five years.
Small sample bias is a generalized form of recency bias. If I have 50 years of data at my disposal, why am I shooting myself in the foot by making an important monetary decision based on a measly sample of three years of data?
Investor Mistake 8: Wanting to beat the market or believing the experts can
Since the 1960s, a now gigantic body of academic research has shown that in a given time frame (e.g. 12 months or 20 years) only a minority of actively investing amateur and professional investors beat the market or an appropriate passive ETF benchmark.
For periods of around five years or more, the proportion of “active loser investors” in stocks and bonds is up to 90%, depending on the study. For study periods of 15 years and more, the loser rate gets closer and closer to the maximum value of 100%.
With regard to the minority of active winners in a given observation period, there is no “consistency of performance”, no “continuity of excess returns”. The composition of the small group of active outperformers changes from time window to time window. Therefore, those who bet on the winners of the past will most likely end up as losers in the future. The historical winners are most likely the product of coincidence.
Therefore, a passive strategy on a buy-and-hold basis is the strategy with the highest probability-weighted return. This does not even take into account the “built-in” tax advantage of buy-and-hold (meaning the tax present value advantage from the long-term postponement of the realization of capital gains into the future - see here).
Investor mistake 9: Making investment decisions based on economic and economic policy data and opinions
Economic data and developments (e.g. about national debt, economic growth, productivity, order situation or inflation of a country or region) have no connection with the returns on stocks, bonds and real estate in the short, medium and long term that can be exploited with sufficient reliability by an investor. By “long-term” we mean periods of up to ten or 30 years. For reasons of space, here is just a single example (we give many other examples in this blog post):
From January 1988 to September 2023 (almost 36 years - longest data series available), the stock market of Argentina, a particularly chaotic and poorly governed country (at least until 2023), significantly outperformed the US stock market and even more significantly outperformed that of Germany (regardless of whether it was calculated in USD or Euro). This happened despite the fact that during these three and a half decades Argentina suffered several sovereign defaults (debt cuts on government bonds), long periods of runaway or even hyperinflation and seemingly endless political mismanagement.
The opposite is true for China: the country has had the highest absolute and per capita economic growth in the world over the last 30 years, but still has a very poor stock market for investors.
In general, anyone who bases investment decisions on economic variables such as economic growth, national debt, unemployment, order statistics, inflation, interest rates or forecasts of these variables - as the majority of economic journalists, finfluencers and representatives of the financial industry explicitly or implicitly recommend - will most likely produce a lower return than an agnostic, broadly diversified buy-and-hold investor.
Investor Mistake 10: Believing return information in traditional media and on the Internet if this information appears particularly high/attractive
The financial industry, journalists and finfluencers regularly publish manipulated or almost fictitious return information. That was the case 30 years ago and it is the same today. The authors of these manipulations almost always present these “fake returns” in such a way that they do not violate any laws or regulatory requirements and are therefore not liable to prosecution. In many cases, the information cannot be verified at all or cannot be verified with reasonable effort - especially not by laypeople. Either way, it is unfair manipulation.
The most widespread form of “completely legal” return manipulation is the age-old “cherry picking”: a large number of historical investments that are generally available to choose from looking back one is selected that has produced the highest or particularly high returns for a certain period of time ending in the present. The manipulator acts in such a way that he himself or the recipient of this information could have known before the start of the period in question that this would happen. In the vast majority of cases this is blatant manipulation.
A concrete form of this method is practiced by fund companies that operate - let's say - 50 actively managed investment funds, but only put the two or three best ones in terms of returns "in the shop window" at a given time, i.e. mention them in their marketing. The audience should get the impression that these two or three best are representative or indicative of the fund company's capabilities. If you put all 50 living funds together and the many dead funds [3] Evaluating the fund company collectively would result in a much worse picture than for them ex post selected three best. This would make it obvious that, based on an objective, truly relevant evaluation, this company did not outperform, but rather underperformed.
The basic rule is: A fund manager, a banker, an asset manager or a finfluencer who speaks in public or in his marketing about anything other than his retrospective “best individual bets” (individual financial products, individual strategies, individual forecasts) has yet to be born.
We have the ancient manipulation technique of cherry picking this blog post for the case of the supposedly “most successful financial investor of all time”. We describe another ingenious manipulation technique - sorry, marketing technique - of the supposedly world's most famous hedge fund manager here. We show a return manipulation technique that is particularly common in private equity here. We analyze how the real estate industry uses the credit leverage effect as a tool to manipulate the returns that can be achieved with real estate here.
The simple conclusion from the (legal) return manipulation, which is unfortunately epidemic in the financial industry and among finfluencers, is: Whenever these people or institutions talk or write about very high returns, there is a high probability that the numbers are not representative, not relevant or completely wrong. The most common manipulation technique is cherry picking.
Conclusion
Investing successfully and creating sustainable wealth is, first and foremost, a question of avoiding mistakes. Anyone who avoids the ten mistakes described here has taken a big step towards long-term investment success.
In general, if you don't start with self-criticism, humility and honesty in your own effort to avoid mistakes, you have little chance of significantly increasing your money in the long term on your own.
“Jackpot investing” – the search for the very best investments in a certain future period of time, i.e. the goal of “having a collection of top investments in the portfolio at any given time” – is a losing game. Investors who are successful in the long term are more likely to make fewer serious mistakes than the rest and lose money less often than the average person. Your secret to success is typically not “hitting the jackpot” with individual investments, i.e. jackpot investing.
The error avoidance focus of successful investors also includes quickly ending their existing bad investments, not repeating mistakes once they have been made, and humbly and rationally disclosing one's own fallibility to oneself and others. [4]
This “negative success principle” works in the area of investing and it also works in life in general. You could call it the “via negativa principle” (“the negative way”). In this blog post We have examined it in more detail and also named the thinkers to whom we owe its formulation.