5 Classic Mistakes

Individual Investors
Make

By:

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1. Thinking that Stocks are

a Better Investment
Because the Market has
Recovered
“Risk is always relative to the price paid.” – Seth Klarman

Stocks are no less risky because the S&P 500 has

recovered from its lows. The stock market’s past
performance is in no way indicative of the risk of investing in
it.

When determining the risk of an investment, investors need

to understand its underlying value. The difference between
price and value determine an investment’s risk. This
difference is also known as the margin of safety of an
investment.

If a stock’s price is lower than its value, it has a margin of

safety thereby lowering its risk. For comparison, a stock
whose price is higher than its value has no margin of safety
and is therefore higher risk.
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2. Investing Without a
Compass
Many investors buy stocks without knowing the underlying
value of the security they’re investing in.

It’s dangerous because they’re not “investing”. They’re

speculating. They might as well put their money on black
and hope the roulette gods will be kind to them.

Speculators risk buying overvalued stocks and selling

undervalued stocks. It’s a recipe for financial disaster.

The solution is investing with a compass.

They can do this by either learning how to do valuations

(Resource) or use a tool like ours (Shameless Plug). It’s the
only realistic way to buy low and sell high, and grow your
money.
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3. Being Impatient
“Investing is where you find a few great companies and then
sit on your ass.” – Charlie Munger

It’s a rite of passage for every investor, and we’re sure many
professionals make this same mistake: They pay attention to
the day-to-day fluctuations of the market.

This often causes investors to be impatient and sell too

early. This could be after the stock has dropped 5% or it’s
suddenly run up 15% over the course of a week. Seasoned
investors ignore these fluctuations and are patient.

Patience in investing has two ingredients: 1. Discipline; and

2. Understanding the Intrinsic Value of Stocks.

When you’re able to combine those two, it’s easier to ignore

the day-to-day fluctuations and focus on the long-term
horizon.

For a detailed look at the benefits of buy and hold, see this
extensive PDF from Legg Mason Capital Management
(Link).
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4. Valuing Wall St.’s

Opinion
The press usually treats the words of Wall Street analysts as
the words of God, reporting each day which firms have
upgraded or downgraded particular stocks.

This often causes individual investors to pay attention to

Wall Street’s opinion. However, this can be detrimental to
their financial health.

First, over 60% of active fund managers underperform the

market (SPIVA). That’s 60% of active fund managers who
are at risk of being replaced by an S&P 500 ETF.

Second, the opinions of Wall Street analysts can often be

contrarian indicators.

Since March 2009, analysts’ favourite stocks have

underperformed the market. Whereas, stocks they liked least
outperformed the market by 88%. (Bloomberg)

Lastly, analysts have their firms’ interest at heart, not yours.

Their recommendations are often driven by business
relationships between their employer and the target
company (Harvard Faculty Research).
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5. Trying to Time the

Market
“We have a lot of fun as the bubble blows up, and we all
think we are going to get out five minutes before midnight
[like Cinderella], but there are no clocks on the wall.”
– Warren Buffett

The idea that investors can time the market is certainly

seductive. We’ve all tried it at least once, but because “there
are no clocks on the wall,” it’s virtually impossible to do with
any level of precision.

The only variant that works is being, “fearful when others are
greedy and greedy when others are fearful.” (Warren Buffett)

When everyone’s shouting, “This time it’s different,” and

acting like the world as we know it is going to end, that’s
probably a good time to start buying.

When authors start writing books about the Dow Jones going
to the moon, that’s probably time to start selling.