My investment career began over thirty years ago. I have spent time on both the retail side and the institutional side of the business. Now I find myself in a position of leadership providing investment guidance and advice to Registered Investment Advisors and their clients. For many years, I have been contemplating the topic of “investment errors.” It is true that institutional investors (the “professionals”) are more sophisticated and make their livings making investment decisions. As such, they tend to know more about investing than retail investors. After all, retail investors are not professional investors and have other commitments and interests that occupy their minds and their time. Nonetheless, both groups are prone to making investment errors. Investment errors take many forms; no type of investor is immune from them. The purpose of this missive is to highlight the errors that are costliest to the investor. By highlighting these errors, my hope is that I can help investors avoid making them. It might also be a useful perspective to help investors find advisors who are best equipped to help them.

10. Unrealistic Expectations

By having unrealistic expectations, investors expose themselves to other problems that arise when investment results do not meet those expectations. What are the most common unrealistic expectations? 1) Expecting high returns—returns that are generally not achievable in the capital markets. 2) Expecting to not lose money. Everyone makes investments that lose money. Understanding the cause of the loss and revisiting the investment thesis will help determine if the losing investment needs to be eliminated. If the investment thesis is wrong, it is time to sell. 3) Expecting to always outperform a benchmark. Almost all investments, even great ones, go through periods of underperformance. Periods of underperformance can go for up to 36-48 months, or even longer, in more extreme cases. Everyone’s experience will be different and there are no guarantees. In all cases, the causes of underperformance need to be evaluated to assess the likely path forward.

Establishing realistic expectations at the outset of the relationship is important and should be one of the first priorities with clients. The advisor should then be held accountable to these expectations on a going-forward basis.

9. Mistaking Luck for Skill

Whether evaluating their own picks or the performance of others, investors can mistake luck for skill. Separating skill from luck requires conversations with the investment decision-maker and careful thinking to understand the investment approach. Usually, individual investors are not particularly aware of the role luck can play in their individual stock picks or in their endeavors to select ETFs, Mutual Funds, or cryptocurrencies. One of the worst things that can happen to an individual investor is a massive stock pick win at the outset. See unrealistic expectations above.

8. Not Taking a Total Portfolio View

Taking a portfolio view (the combined returns of all the investment holdings over some discrete time period) helps keep perspective. This is not to say you should ignore under-performing investments. You must evaluate underperformers. However, if we know in advance that in some time period, some of our investments will outperform and some will underperform (but we don’t know which investment will underperform), it makes it easier to accept when we get underperformers. Let me put this in context. I used to work with large pension plans who would outsource their entire retirement portfolio to our firm. This would include multi-asset, multi-style, and multi-manager portfolios (so-called M3) across the globe. Invariably, we would have some funds (comprised of multiple managers) that underperformed. Certain clients liked to focus on the underperforming funds or the underperforming managers inside the funds. This would lead to performance watch lists and eventually the clients would start eliminating certain funds inside the program (even if we were delivering to expectations in the aggregate). All funds will spend some time underperforming—this is just the reality of investing. Firing underperforming managers indiscriminately is akin to a baseball team trading a player due to occasional errors when the team is having a winning season. Eventually, this would lead to the elimination of the relationship in its entirety. Taking a total portfolio view allows a well-established investment process to deliver results in the aggregate. Rather than second-guessing each individual investment, it is better to start with a total portfolio outcome first, and then looking at the contribution of each investment.

7. Mental Accounting

Mental accounting is a term developed by behavioral economists to describe certain investor cognitive errors associated with their investments. Mental accounting involves projecting factors that are unique to you onto the broader market. An example would be “anchoring” to the price you paid for an investment. The market doesn’t care at all what you paid for an investment. Accounting your cost basis into an investment decision (to sell or hold) is an error. Another example is “it’s not a loss until I sell it.” This is not true. There is a loss whether you realize the loss or not. Being aware that there are things you think are important that the market doesn’t factor into price is an important investing skill to develop. Eliminate all these things from your investment thesis.

6. Portfolio Concentration

This is straightforward: putting too much of your wealth into a single investment. This can be ruinous. While all investments should be viewed relative to their contribution to total portfolio risk, there should be an absolute maximum. For a single stock, it should probably never comprise more than 10% of your total worth. An investment strategy (a mutual fund or an ETF or a separate account) should probably never exceed 20% of your total worth. Of course, these are just guidelines, and everyone’s situation is different, but the financial advisor should discuss this issue and hard wire some hard limits into asset maximums. It is a fair reminder that any investment under the right conditions can go to zero. There are no guarantees.

5. Improper Diversification

This could be too much in a single asset class–e.g., only owning stocks-or improper diversification within an asset class–e.g., only owning technology stocks. The tried-and-true methods of diversification: owning some of all asset classes, using multiple money managers, owning stocks from all sectors of the economy, owning both corporate and government bonds, and owning assets globally, are all reasonable approaches. Advisors and their clients should

have a good handle on the client’s suitability and risk tolerances, and then should devise their allocations to asset classes and geographies, as well as establishing proper benchmarks, in advance of building their portfolios.

4. Home Country Bias

This could have gone in the diversification section, but it is a big enough mistake to call out. Many investors only invest in their home country, particularly US investors. This is a mistake. US stocks represent only about 40% of stocks globally. While US stocks have dominated other geographies in recent years, there will come a time when US stocks lag. Investors are well served owning a global stock portfolio.

3. Failure to Rebalance

Portfolio allocations to asset classes, individual strategies, and individual securities are made with two things in mind: their expected contributions to return and to risk. When performance over some period of times causes investments to drift away from initial weightings, unintentional risks and biases can creep into the portfolio. Rebalancing periodically back to initial weighting targets is a prudent risk management tool.

2. Performance Chasing

Many times, investors are enamored by things that have done very well and then after a period of strong performance add that stock, or fund, or asset class to their portfolio. This is called performance chasing. It happens far too frequently, particularly when an advisor is not involved. There have been studies that show investors on average experience half the returns published by most mutual funds because investors pile into the funds after a period of strong performance. You don’t earn what has been produced in the past, you earn what is produced after you invest. The forces of mean reversion can be powerful in the markets. Moreover, sometimes people bake performance chasing into their investment decisions by requiring investments fall into the top quartile of performance. This is a mistake as well. Chasing strong returns is almost a guarantee for mediocre (or worse) performance. Resist the temptation to chase the hot fund or investment. You can take your time making these kinds of decisions and wait for things to come your way rather than chasing.

1. Market Timing

It is surprising how many sophisticated investors get blown out of their investments when market volatility increases. I’ve witnessed large US pension plans and endowment plans capitulate during market lows in my career. This happened in the Great Financial Crisis of 2008-2009 as well as during the Covid sell off of March 2020. People panic and make bad situations worse by bailing out at or near the bottoms. Once a decision has been made to go to cash, it tends to be a disaster because it is now an emotional rather than an intellectual decision. Plus, the dynamic is challenging because you not only have to be correct on your exit but also your entry. Avoid this at all costs. I equate this to the dynamic of large-scale mountain climbing. Know what your policies should be in advance of bad things happening. For example, turn back if you don’t make the summit by 1 PM. Having a plan in place in advance of the bad thing happening will keep your mind calm, and emotions in check when volatility strikes. Have a plan in advance and stick with it. Avoid timing the market.

The above mistakes are costly to investors. There are others, like paying too much attention to taxes or not enough attention to taxes. All of them can be avoided by developing a well-constructed and thought-out investment philosophy and investment policy statement for each client. Such a document should be produced at the outset of the client relationship and signed by both the advisor and the client. It should set the tone for a well-functioning client relationship.

Erik Ogard, CFA®

Chief Investment Officer

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which Investment(s) may be appropriate for you, consult your financial advisor prior to investing. Information is based on sources believed to be reliable, however, their accuracy or completeness cannot be guaranteed. Statements of forecast and trends are for informational purposes and are not guaranteed to occur in the future. There is also no assurance that any investment strategy will assure success or protect against loss.