Russell Fuller Russ Fuller is President and Chief Investment Officer of Fuller & Thaler Asset Management, based in San Mateo, CA. He sits on the editorial boards of the Journal of Portfolio Management and the Financial Analysts Journal . Common mistakes investors make Introduction For amateur investors whose goal is to 'beat the market', we first suggest that the following facts should be accepted as truth. -
Few investors, including professionals, beat the market. You are unlikely to be one of the lucky ones. -
Most strategies to beat the market involve having either better information or making better use of that information. Neither approach is likely to work for an amateur. Why should your information be better than the information available to mutual fund managers who may have hundreds of analysts at their disposal? These facts do not imply that it is impossible to beat the market, just that it is unlikely. At Fuller and Thaler we attempt to beat the market by exploiting the biases exhibited by other investors, and so far, we have been successful. However, our strategies would also be difficult for a home investor to implement. So, we suggest the following rules to make personal investing more successful. -
Avoid overconfidence. Most people are overconfident. Surveys reveal that over 90 percent of drivers think they are above average! This natural tendency toward overconfidence can be reinforced by sloppy bookkeeping. Few individual investors make a serious attempt at keeping track of their investment performance, and those who try often make mistakes, most famously illustrated by the Beardstown Ladies, who miscalculated their historical rate of return. If you really think you have beaten the market, we suggest checking your math. -
Avoid 'hindsight bias'. Most of us have 20-20 hindsight. We all now remember being sure that the internet bubble would burst, and may even delude ourselves into thinking that we thought that it would end in early 2000. Of course, none of us have this kind of omniscience in real time. Hindsight bias helps produce overconfidence by clouding our memory of how we have really done over time. If you want to really see how your predictions have held up over time, keep track - and get ready to be depressed! -
Avoid compounding your past mistakes via regret . One of the real benefits of managing one's own portfolio is the ability to sell losers for tax write-offs, and hold on to winners long enough to pay a lower capital gains tax. Many investors tend to do the opposite : they sell their winners to lock in a gain and hold on to their losers in the hope that they will be able to break even. Smart investors are willing to take their lumps . -
Diversify, diversify, diversify. The biggest mistake individual investors make is concentrating their portfolios, and the greatest sin of all is holding an excessive portion of your wealth in the stock of the company you work for. Many employees have more than half their 401(k) investments in their own company stock. This is a disaster waiting to happen. -
Don't take yourself too seriously. Relax, buy no-load index funds and spend the money you save on fine wine. (We particularly recommend good Australian Shiraz.) You will enjoy life more and even live longer! www.fullerthaler.com |