3 Common Investment Traps and How to Avoid Major Portfolio Damage

These three mistakes can end up costing investors a lot of money and wreck their portfolios.
By Kim Iskyan ,

Investors can lose money in a lot of ways.

Here are three common mistakes that investors make and how to make sure that they don't wreck their portfolios.

1. Regretting purchases
Once an investor has locked in a buy order, a range of emotions may occur, such as pleasure, excitement, worry ... or regret. From buying stocks to buying a new refrigerator, it is easy to second-guess a purchase when a lot of money is involved.

The feeling of doubt after a large purchase is called buyer's remorse.

Beating oneself up after buying won't change anything. In fact, it might even cause the buyer to impulsively sell an otherwise terrific, long-term investment.

How to avoid it: Investors should know what they're getting themselves into, and do research before making any big purchasing decisions. Not only will this help prevent impulsive purchases, it can also help reduce buyer's remorse.

Also, investors shouldn't just think about the price they are willing to pay but the lowest price at which they are willing to sell.

Then set a mental stop-loss to prevent major losses. This way, the investor can sleep easy knowing there is protection available in case things don't go according to plan.

2. Following the crowd
It is easy to think that if everyone is doing something, it must be the right thing to do, but in reality, this isn't a good reason to do something, especially when it comes to money. In fact, it might be a very good reason not to do something.

The driving factor behind market bubbles is a crowd or mob mentality. People and the media get excited about a new investment and prices skyrocket.

Not wanting to miss out, investors jump on the bandwagon as prices peak.

And just as quickly, prices plummet when the crowd sells everything at the first signs of danger. Investors panic and dump shares as well, locking in the loss.

How to avoid it: Stay ahead of the crowd. Be informed enough to make one's own decisions.

And what our parents used to say, that just because everyone else is doing it, doesn't mean that you should, too, is good advice.

Be more of a contrarian. If the news and your friends are overly optimistic about stocks, look at the other side of the story.

Conversely, if everyone is bearish, it might be a great time to buy.

3. Assuming someone else cares about your money as much as you do
Financial professionals aren't our friends. As far as they are concerned, we are walking ATMs.

There is even an acronym for it: SOW, which stands for share of wallet, referring to what percentage of an investor's money they manage. The higher the SOW, the more fees they earn.

Financial advisers' clients reasonably assume that they have their best interests at heart, but that is often not the case.

Depending on the type of adviser, he or she may be subject to suitability but not fiduciary rules. 

Suitability means that if a client has a complaint about a bad investment, an adviser only needs to justify why he or she felt the investment was suitable. There is no legal obligation for an adviser to act in the best interest of clients.

Fiduciary duty refers to a legal obligation for advisers to do what is best for clients, regardless of the adviser's personal gains or losses.

The good news is that in April, the Department of Labor announced the final version of a fiduciary rule, which means that investment advisers who manage retirement accounts but not all investment accounts will have a fiduciary duty to clients. The rule goes into effect next April.

This means that advisers who accept commissions or revenue sharing as part of their compensation will have to get clients to sign a best interest contract exemption. This says that the adviser will only earn reasonable compensation and will act in the client's best interests.

If investors who have this agreement in place then think that the adviser hasn't put their interests first, they can take them to court and sue for damages. This will be a major change for some American advisers.

Most financial advisers are honest and know what they are talking about, but that doesn't necessarily mean they will put investors' interests first.

How to avoid it: Investors care more about their own investments than others do. They should ask questions if necessary and not shy away from asking advisers for reduced fees.

In addition, advisers should be sure that they are well informed before agreeing to anything. And keep in mind that there are some advisers that should be avoided.

Legendary investor Peter Lynch said, "Invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator."

Although he was talking about stocks, this can and should be applied to other financial instruments or advisers.

Avoiding these three mistakes won't mean that investors will make money. But they will help prevent major damage to investment portfolios.

For more on the investment pitfalls to avoid and how to avoid them, download this free report by clicking here.

This article is commentary by an independent contributor. 

Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.

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