7/25 The 6 Biggest Mistakes DIY Investors Make and How to Avoid Them
Over the last several months, I have met with quite a few self-proclaimed do-it-yourself (DIY) investors who, after struggling with the markets in 2022, approached me asking for a second opinion. Interestingly, almost every self-directed investor I've met has experienced similar setbacks. As the market continues to evolve, these investors are experiencing a mixture of successes and challenges.
But mostly challenges. One landmark study showed that the average equity investor posted an average annualized return of 6.81 percent for the 30-year period ending on December 31, 2022. That's below the 9.65 percent return of the Standard & Poor's 500 Index for the same period of time. Put another way, after 30 years, the DIY investor's original investment of $100,000 increased to almost $722,000. But the S&P 500 account was worth more than $1.59 million.1
This illustration is an example of what can happen over the long term. Keep in mind that it's unlikely that a portfolio would be a 100% investment in the S&P 500, which is an unmanaged index considered to be representative of the overall U.S. stock market.
But the point is clear. An individual can be their own worst enemy when it comes to investing.
The study concluded, "Often succumbing to short-term strategies such as market timing or performance chasing, many investors lack knowledge and/or ability to exercise the necessary discipline to capture the benefits markets can provide over longer time horizons. In short, they too frequently react to market maturations and lower their longer-term returns."
In this article, we will delve into the six most common mistakes that I’ve seen DIY investors make and provide insights on how to potentially overcome them. By recognizing these pitfalls, you may be able to make smarter decisions and position your portfolio for long-term growth.
1. Diversification Dilemma
A well-diversified portfolio can be a key cornerstone of a successful investment strategy. Unfortunately, many DIY investors find it challenging to strike a proper balance. A lack of diversification may lead to a higher-than-expected risk profile, impacting your portfolio's overall performance.
To manage this mistake, take the time to understand what types of investments you own and how they are positioned. And remember, diversification and asset allocation are approaches to help manage investment risk. They do not guarantee against investment loss.
2. Emotional Roller Coaster
Emotions can be a DIY investor's worst enemy. When the market is volatile, it's natural to feel stressed or anxious. However, emotional decision-making can lead to impulsive buying and selling, often at the wrong time.
To keep your emotions in check, establish a clear investment strategy, and stick to it. Focus on your goals, time horizon, and risk tolerance rather than short-term market fluctuations.
3. Overconfidence Trap
The overconfidence trap is a common pitfall for DIY investors. It's easy to assume that past successes will continue, whether the markets are trending higher or lower. This overconfidence can cause you to be out of position during a period of volatility.
To avoid falling into this trap, approach investing with humility, and recognize that the financial markets are full of surprises. Conduct thorough research, assess potential risks, and make informed decisions based on data rather than intuition.
4. Fees & Taxes Oversight
Fees and taxes can have an impact on your investment returns. However, many DIY investors overlook these costs when making decisions. High fees can erode your returns, while inefficient tax management can generate expenses.
Remember, this article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult a financial professional if you have questions about fees and taxes. Your financial professional may need to consult with a tax professional before modifying your investment strategy for tax-related reasons.
5. Inconsistent Portfolio Reviews
Regular portfolio reviews can help your investment strategy. Unfortunately, many DIY investors neglect this step. Without periodic evaluations, your investments may drift from your original goals, and you may overlook opportunities to rebalance or adjust your strategy.
To avoid this mistake, set a specific time to conduct a portfolio review. Ask yourself questions like, "What role is this investment playing in my portfolio?" and "Have any investments reached my target price?" or "Have any investments slipped below an established price floor?"
6. Hesitating to Seek Advice
Many DIY investors believe they can handle everything themselves and are hesitant to seek professional advice. However, even the most experienced self-directed investors may benefit from guidance from a financial professional.
Don't be afraid to ask for help. A licensed financial professional may have access to resources that can offer some key insights, and they are trained to consider a wide range of factors before determining if an investment fits your goals, time horizon, and risk tolerance.
DIY investing can be a rewarding journey if you're able to learn from your mistakes and make adjustments as different market cycles emerge. You may be better positioned to pursue your investment strategy if you can recognize these common challenges.
Some DIY investors maintain a smaller account for their speculative endeavors while working with a financial professional to help them position a larger portfolio based on their goals, time horizons, and risk tolerance. This collaboration allows DIY investors to potentially benefit from financial professional training while still retaining control over a portion of their investments.
Remember, knowledge is power, and continuous learning is one key to long-term success in the ever-evolving world of investing.
1 Dalbar’s Quantitative Analysis of Investor Behavior Report, 2023: April 3, 2023. The Standard & Poor’s 500 stock index is not indicative of the past performance of a particular investment. Individuals cannot invest directly in an index. The returns and principal values of stock prices will fluctuate as market conditions change. Shares, when sold, may be worth more or less than their original cost.