How No t to Invest

June 1, 2009

The biggest blunders of affluent investors - and how to avoid them.


We all do dumb things.

When it comes to investing, sometimes we do really dumb things.

Even Warren Buffett, the world’s most famous investor, admitted to some big gaffes in his letter to shareholders last spring.

“During 2008 I did some dumb things in investments,” he wrote. “I made at least one major mistake of commission and several lesser ones that also hurt. … I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.”

Whether shareholders in Buffett’s Berkshire Hathaway stock took comfort in the frankness is for them to decide. For investors in general, though, the acknowledgement serves as a reminder about the powerful lessons mistakes can teach.

If the famed Omaha investor had such a challenging year - shares of Berkshire Hathaway lost 36 percent of their value during the four quarters that ended March 31 - then what chance do you have? Hard times can force investor mistakes, and advisers say that is certainly happening to affluent investors today.

Many investors feel that even long-held principles like buying and holding stocks for the long term has been a mistake, says Mark Balasa, a financial adviser with Balasa Dinverno & Foltz LLC in Itasca, Ill., whose practice is about 20 percent physicians.

“And they have a point,” says Balasa. “I’ve been telling clients all along to hang in there and that’s been dead wrong.”

He’s been wrong of late, that is. But like most advisers, he still thinks investing in good companies and holding them for the long-term makes sense. In fact, he argues that the opposite approach - bailing out as soon as the going gets tough - is the biggest dumb mistake investors make.

Mistake No. 1: Bailing Out

“I had a physician client call me recently from a vacation in India and told me to go 100 percent into bonds, and another one called from an island vacation the same week asking for the same thing,” Balasa says.

When you pull completely out of stocks and opt for supposedly “safer” bonds, you’re betting everything on an absolutely bear market, says Georgette Frazer, a financial planner and chief executive of Lifetime Financial Services LLC in Marshfield, Wis. You’re also saying (whether you realize it or not) that you’ll be able to recognize when the time is right to move back into stocks.

“It’s a fear trap and it causes people to make big, expensive moves,” says Frazer.

The fix, she says, is to re-evaluate your true tolerance for taking risk in the stock market, which may involve coming to a middle ground between the fear you felt as stocks started to implode in 2008 and how you felt the year before.

“Well educated people can understand the long run and themselves,” though that’s not to say it’s always easy, she says. “In some ways investing is counterintuitive because when your gut tells you to get out, it feels like a natural response to stop what’s hurting you.”

Mistake No. 2: Jumping into Exotic Ideas

Physicians often are presented with opportunities to invest in illiquid, complex investments, says Balasa.

“They’re sexy and not everyone can get into them,” which make them attractive to some investors, he said. “But there’s a cost for that lack of transparency.”

That attraction can also translate to new untested portfolio management styles, Frazer says.

“I see people taking action just to help themselves feel better,” she says. “People get attracted to a new idea that’s supposed to be for high-income clients and they’re ready to throw out modern portfolio theory.”

It’s true that modern portfolio theory has taken a beating of late, but alternative investments and investment strategies have plenty of their own problems.

“Buy and hold feels broken, but annuities, market timing, structured notes - they all have their own hair and warts,” Balasa says.

Mistake No. 3: Letting Past Mistakes Rule

Maybe you didn’t bail entirely out of stocks, but you certainly dumped that exchange-traded fund with exposure to emerging markets, right?


If so, then you’ve probably made another common mistake, Balasa says. Although developing markets around the world took a huge hit in the meltdown that began last year, they will account for a disproportionate share of future economic growth, he says.

Affluent investors often try to fix previous mistakes by changing strategies drastically - to their detriment, Frazer says.

“They get too emotionally tied to individual positions that were good for awhile but now they should be diversifying away from those,” she says.

The antidote is to have a long-term investment plan that stresses diversification and has been tested using Monte Carlo simulations, a rigorous set of computations that put a portfolio through thousands of market scenarios to see how it would perform, she says.

Mistake No. 4: Forgetting the Small Stuff

Facing major investment losses, many overwhelmed investors lose sight of daily ways to protect their wealth, Balasa says.

“Attending to debt levels - not taking out a car loan that exceeds the value of the car, not layering on credit card debt to finance a vacation - can make a big difference,” he says.

Likewise, harvesting capital losses for tax breaks is another way to make sure you are making the most of the things you can control as an investor, rather than wringing your hands about what’s out of your control, he says.

Whether you’ve made these mistakes or others, it’s important to keep in mind the upside. As Buffett told shareholders about why he isn’t too bothered by his portfolio losses:

“We enjoy such price declines if we have funds available to increase our positions. Long ago Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

Janet Kidd Stewart is a freelance writer based in Marshfield, Wis. As a contributing columnist for the Chicago Tribune, she writes a weekly, syndicated retirement column called “The Journey” that appears in Tribune newspapers across the United States. She holds a bachelor’s degree and master’s degree from the Medill School of Journalism at Northwestern University. She can be reached via physicianspractice@cmpmedica.com.

This article originally appeared in the June 2009 issue of Physicians Practice.