10 Common Investor Pitfalls and How to Avoid Them

By Somerset Advisory on October 25, 2023

Following a difficult 2022, most fixed income and equity asset classes find themselves in positive territory on a year-to-date basis. This recovery offers investors a crucial opportunity to reflect upon their investment strategies with an eye toward making informed decisions for the future. While global economic and market dynamics often lead many investors to say, “this time is different,” here are 10 common pitfalls to avoid that will serve you and your balance sheet well across market cycles.

1. Undefined investment objectives

If the last few years have taught us anything, it’s that we never know what challenges might be around the corner. Rather than making frantic, sudden changes to avoid the proverbial bumps in the road, long-term investment success involves constructing a well-diversified portfolio aimed at providing the appropriate levels of risk and return needed to meet your unique life goals. In our opinion, even after thoughtfully building your portfolio, you also need a certain level of resilience to navigate day-to-day, month-to-month and year-to-year market volatility. Be sure you have a pre-defined process that keeps you focused on your goals ― instead of short-term volatility ― during periods of market stress and allows you to evaluate whether you remain on track for achieving them.

2. Lack of diversification

Over the years, numerous academic studies have shown the mix of asset classes in your portfolio have a far greater impact on investment outcomes than security selection or market timing. With equity and fixed income market leadership frequently shifting, we believe an appropriate level of portfolio diversification offers the best path toward arriving at your stated risk and return goals. Many times, investors attempt to magnify returns by taking on large exposure in one particular security or sector; however, when markets push back against such concentrated positions, the results can be disastrous.  

3. Trading versus investing

Jean-Jacques Rousseau said, “Patience is bitter, but its fruit is sweet.” Experiencing the ultimate “fruits” of any investment strategy requires time. Frequent tactical modification of your portfolio can reduce returns through greater transaction fees and/or taxes, but it can also lead to selling winners or buying losers too early. Investors should always have a process to determine when portfolio metrics have shifted meaningfully enough to warrant a strategic reallocation or rebalancing.

4. Misaligned risk

Risk is a necessary evil in investing. However, taking on too much risk can lead to outsize variations in performance that may take you outside your comfort zone, and this rarely ends well. On the other hand, taking on too little risk may result in returns that cause you to fall short of your financial goals. Understanding the level of risk you’re comfortable with, as well as the level of risk required to achieve your goals, is an exercise that must take place regularly throughout your investing lifetime.

5. Infomania

There is no shortage of media outlets, social media influencers or publications aiming to grab your attention by sharing “tradable” information. However, with one yelling “buy” and the other shouting “sell,” sometimes separating real news from noise can be difficult. One good rule to keep in mind, regardless: In most cases, by the time news arrives in your inbox or social media feed, it has likely already been priced into the market.

6. Timing the market instead of giving the market time

The temptation is ever present, but seeking to capture that perfect market moment to invest is not only extremely difficult, it’s also horribly ineffective. For example, an investor who was out of the market during the top five trading days for the S&P 500 Index from January 1, 1980, to December 31, 2021, would have experienced a 43% reduction in their cumulative return versus staying fully invested.[i] This vast difference between the two outcomes highlights the merits of staying the course rather than attempting to trade in and out of the market at just the right time.

7. Letting the good times roll

As Warren Buffett famously opined, “Be fearful when others are greedy and greedy when others are fearful.” While we certainly wouldn’t advocate trying to time the market or sitting on large piles of cash until stock prices fall, recency bias often leads investors to increase already outsized positions in their portfolios. Maintaining a diversified portfolio across fixed income, equity, real assets and, in some cases, alternative investments, allows investors to thoughtfully take chips off the table in areas that might be running a bit hot while leaning into potentially more attractively valued areas.

8. Becoming your own worst enemy

According to a recent survey conducted by CreditWise, finances were cited by participants as the leading cause of stress in their lives ― ahead of work, family and politics.[ii] The process of growing, maintaining and distributing wealth is bound to bring with it significant emotions; many of which, if left unchecked, could lead to making decisions detrimental to longer-term results. As a forward-thinking long-term investor, it’s important to partner with an experienced, objective advisor who can guide your portfolio during volatile market climates and unexpected changes in your life.

9. Failing to control the controllable

No matter what level of planning you do, the future is inherently uncertain both in life and financial markets. However, where the power of precision evades us, the power of preparation shines. While you can’t move markets, you usually can control ― at least to some extent ― how much you save. Continually investing additional savings can have as much, or more, of an influence on your wealth as the return your portfolio achieves. Similarly, while you can’t predict when the markets will fall, it is likely you can come up with creative ways to spend less. 

10. Sub-optimal allocations to active versus passive investment strategies

In the seventh iteration of “The Next Chapter in the Active vs. Passive Debate,” the research team at Fiducient Advisors measured the efficacy of actively managed mutual funds across 17 different asset classes. Despite the very favorable equity investing environment captured during the 10-year evaluation period ending December 2022, their primary observations remained consistent with those of past versions: Even the best active managers may spend a considerable amount of time in the bottom half of their peer group.

The question then becomes, is sitting through an underwhelming period of performance ultimately worth it? It depends. For some asset classes, where replicating an index is easy and the probability of consistently generating additional (above-index) returns is historically low, a passive approach, which provides broad diversification at reduced costs, is warranted. In other asset classes, where index replication is more difficult and the odds for excess returns are more favorable, active management makes sense. Working with an advisor who can help you identify where active management fees are justified by return potential can have a significant impact on your portfolio’s net-of-fee return over time.

For more information, including how you can seek to avoid these common pitfalls in your personal financial journey, please contact us.

[i] Long, Bradford, “The Bear Market Field Guide,” Fiducient Advisors, June 30, 2022, https://www.fiducientadvisors.com/blog/the-bear-market-field-guide. Accessed September 25, 2023.

[ii] White, Alexandria, “73% of Americans Rank Their Finances as the No. 1 Stress in Life, According to New Capital One CreditWise Survey,” June 15, 2023, https://www.cnbc.com/select/73-percent-of-americans-rank-finances-as-the-number-one-stress-in-life/. Accessed September 25, 2023.