“All investors make mistakes. The trick is to avoid making the same mistake twice,” says Tim Bennett in the MoneyWeek article “Five Common Mistakes to Avoid.”

The article summarizes the pitfalls James Montier, a behavioural economist, warns against in his latest book The Little Book of Behavioral Investing.”

There are a lot of potential mistakes people make when investing, but here are the five most common stock market mistakes!

Five Stock Market Mistakes To Avoid When Investing

1. Impatience Equals Lower Average Investment Return

Montier notes that the average stock holding period is now 6 months as compared with 7 to 8 years in the 1950s and 1960s (based on NYSE data). This impatient behaviour can be counter-productive as modern (ie frequent) investors could earn approximately 6% less return than the market.

Both Montier and Bennett advocate a long-term strategy: patience and holding back on investment if there are no good opportunities within the 6 months.

2. Daily Stock Market Results Can be Distracting

According to Montier, “distracting noise” contributes to over-trading. Investors are exposed to daily barrage of stock market news and tips. This daily “noise” should have no impact if the investor’s initial reason for buying was well thought through.

And if the investments were chosen for their long-term return.

To avoid what is possibly a haphazard reaction to the daily stock market tribulations, Bennett advises sticking to these three rules :

• determine whether the stock is undervalued (eg by checking price/earnings ratios and dividend yields)
• determine if the company is likely to become insolvent (eg by using the Altman Z score)
• check if the company’s management is adding value (as opposed to the management misspending).

3. Right Can be Wrong When Making Investment Decisions

In his book Montier also advises against being over-confident whilst making investment decisions. People do not like to be wrong so they are more likely to look for data supporting their investment choices… Rather than look for information that may discredit them.

The way to overcome this type of behavior is to do a SWOT analysis (strengths, weaknesses, opportunities and threats) on all major investments. The trick is then to concentrate on the investment’s weaknesses. This is to try and see whether these would influence the buying decision.

4. Portfolio Diversification Gives Best Investment Return

Montier states that “we hate losing more than we enjoy winning” and are likely to hold on to an investment even though it proves a flop. However, investors should remember that the money thus invested could be generating income elsewhere.

To help investors who find it difficult to let go of their bad choices, Bennett recommends setting a limit on the investor’s portfolio. IE: where no single holding would account for more than, say, 5% of the total portfolio. Keeping to this low limit will make it psychologically easier to sell if the holding is a dud.

5. Investment Bubbles and Stock Market Mistakes

Montier blames over-optimism for the existence of the investment bubbles. Investors commonly believe they will be able to sell before the bubble bursts. But, by the time many of them make this decision, it is often too late.

The advice, therefore, is to stay out of the bubbles completely!

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