Learn From Your Investment Mistakes

by Alan Lavine and Gail Liberman

When it comes to investing, we all seem to make the same mistakes. Hopefully, we can learn from them.

John Nofsinger, a behavioral finance expert and author of "Investment Blunders of the Rich and Famous (Prentice Hall)," says our foul-ups fit into three categories.

* Psychological bias. We are overconfident in our ability to pick the best stocks, bonds or mutual funds. If we're wrong, we hang onto our losing investments in the hope that they'll bounce back. We don't want to admit that we failed. Or, we give up responsibility by hiring others to manage our money. Then we don't pay attention to what they are doing.

* Emotional. We invest based on emotion--often fear and greed--instead of facts. For example, we might invest hoping our stock or bond fund will go up--not based on the financial strength of the company, its earnings and the outlook for the economy.

* Simplification. We see patterns in random events, such as stock price movements. Then we make investment decisions based on false patterns.

The desire to beat the market can lead to all sorts of money-losing problems. They range from chasing mutual funds based on past performance to succumbing to get-rich-quick schemes. Even a good mood can prove damaging when it comes to investing. Optimism tends to make investors less analytical and more likely to take bigger risks, he says.

Nofsinger cites research that shows the popular investment strategies--relying on market timing, investment analyst or newsletter advice, mutual fund rankings, and tracking of insider trading--don't work very long.

Research also demonstrates the limitations of relying on professional money managers. Pros make the same behavioral mistakes as individual investors.

Now that we know what's wrong, how do we fix it? Most investors spend too much time selecting securities and timing the markets, Nofsinger says. But he points out that 90 percent of an investor's return is based on how they allocate assets. The trick is to own different assets to spread your risk. A simple mix of 50 percent stocks and 50 bonds, for example, is half as risky as a 100 percent stake in the stock market.

Investors also need to be more realistic in their expectations of what they will earn in the stock market, he says. They should save more and minimize investment expenses. They should invest in stocks, bonds cash and real estate. They should also hedge against inflation by investing in real estate, precious metals and inflation-indexed Treasury bonds.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.