Humans have a number of unfortunate tendencies that get in our way when it comes to investing: We see patterns where none exist. We have difficulty conceptualizing long arcs of time. We selectively perceive what agrees with our preexisting expectations and ignore things that disagree with our existing beliefs. We tend to forget our losers and overemphasize our winners. In short, we simply are not wired for investing.
We cannot avoid these built-in shortfalls. But at least if we are aware of them, we might hope to avoid their most pernicious effects.
9Confusing past performance with future potential: We’ve all seen the boilerplate disclaimer that comes with anything investment-related: “Past performance is no guarantee of future results.” Despite its ubiquity, this warning is routinely ignored by investors.
Consider this. When Morningstar gives a mutual fund a five-star rating, the fund attracts lots of new investors and fresh dollars. The primary factor in the rating is (can you believe it?) past performance. This despite a Morningstar study that found that five-star funds mostly underperform — my assumption is that it’s a case of a simple reversion to the mean. As it turns out, a fund’s expense ratio is a much better predictor of performance.
When making any investment, be sure you are not merely chasing a hot quarter or two.
10When paying fees, get what you pay for: It always surprises me how much money some people are willing to throw at others to manage their financial affairs when it is not necessary.
For many people, hiring a pro makes good sense. Let’s say you have a complex financial situation. You may have a complicated tax issue, or perhaps you have a generational wealth transfer coming up. Then sure, it makes lots of sense to employ a professional. Lots of clients are too busy running their own businesses and do not have the time to manage their investments. But many others might be better off simply dollar-cost-averaging into a group of broad indices.
Consider what sort of financial planning help you need, and find someone competent to assist you. If your needs are straightforward and simple, you might be able to save the fees and do it yourself.
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. You can follow him on Twitter: @Ritholtz. For previous Ritholz columns, go to washingtonpost.com/business.