Doing the Wrong Thing at the Wrong Time
Common investor mistakes during times of stress
I ran a registered investment advisory firm for 12 years. I enjoyed my time as an advisor and hope to contribute to the field in the future. My firm was small - I had only a handful of full-service clients. I managed each family’s assets and developed financial plans for these clients. I also worked with planning-only clients, where I developed financial plans for clients, and they were responsible for their implementation and investment. Despite having a small client base, I’ve talked with many prospective clients, pro bono clients, and people generally interested in learning more about investing. These conversations influenced my perspective on “retail” or amateur investors. These investors are often vilified in the press or financial circles and disparagingly called things like “dumb money.”
First off, I came to think of these investors in a different light. In many respects, they are “forced” investors. Many people I have talked to are not thrilled about managing their retirement money. But with the death of the traditional pension, there is little choice. The rise of 401ks and other self-directed retirement accounts forced people to take control of their retirement investing - often unwillingly. Viewed from that perspective, is it surprising that self-directed investors make fundamental errors when managing their own money? Most people that read a newsletter like this one have a good grasp of investing and business. If you have read an annual report, 10K, or proxy statement, you are probably in the top 5% of self-directed investors.
Based on my observations, self-directed investors' mistakes tend to happen at extremes. Most investment programs suffer from what I would consider benign neglect. People saving for retirement understand the necessity of contributing to their retirement accounts. Usually, they follow through with a kind of dutiful contribution plan. They regularly contribute to their 401k or other plans without thinking too much about it. Maybe once a quarter or so, they check their statements and see a modest increase and feel pretty good about where they are heading. However, at market extremes, they can feel intense pressure to act, and it is not always in their best interest to do so. The media attention can be overwhelming at extremes. Investing is usually pretty dry and dull. By the time it makes it to the front page of the popular press, we are likely at some type of market extreme.
Are we at a market extreme? I have no idea. But I think investors could feel intense pressure to “do something” as they see their account balances shrink for the first time in many years. Here is a non-exhaustive list of the types of mistakes that I have witnessed people make:
They stop contributing: It is often very psychologically appealing to stop your contributions during times of market turmoil. I started my firm in 2009. I talked with many investors who were still unwilling to invest even in 2012 and 2013. Living through a brutal bear market can be very scarring for people, and their willingness to get back into the investing habit can take a long time to recover. Of course, in hindsight, we see that continued investment would have been the correct decision, but it is often difficult to accept that during times of stress.
They go to cash: If stopping contributions is a misdemeanor, then going to cash is a felony. I have met with many self-directed investors who went to cash during a bear market. They then faced the unhappy prospect of deciding when or if to re-invest in the market. This is doubly psychologically difficult. Not only did you sell during a bear market, you now have to find the “right” time to reinvest. Just the mental stress of this exercise is so great that many people choose to ignore it instead.
They look for alternatives: When mainstream stock and bond investing becomes too painful, self-directed investors look for other ways to protect themselves. Then “alternatives” become more popular. This can take many shapes: insurance products, hedged equity, real estate, and even your neighbor’s private business. Many of these types of investments are frighteningly complicated. They are often sold rather than bought. And they often prey on the fear prevalent at the time.
They chase hot products: I closed my investment firm in 2021. The Covid crisis notwithstanding, the markets had a spectacular run for many years. In the year before I closed my firm, I had more people talk to me about investing in the Nasdaq, one of the ARK opportunity funds, or even just a basket of “Google, Netflix, and Facebook” because they had done so well. This is the opposite of the bear market fear. The jubilant “I want some of that too!” that you experience at the end of a long bull run.
The thing that I like to keep in mind is that these particular types of mistakes happen at market extremes. They are behavioral mistakes rather than logical mistakes. The behavioral aspects of investing can be every bit as hard - harder even - than learning about stocks, bonds, index funds, and ETFs. Hopefully, being aware of some common pitfalls can help people you know navigate difficult times.
