Every investor makes mistakes. I should know. I'm an investor and I make errors all the time. We make mistakes with our money because we can't predict the future. We get it right sometimes... but not every time. And when we get it wrong it costs us money. Ouch.
But it's important to keep things in perspective. These mistakes won't necessarily sink your financial ship. There are plenty of people who invest and do quite well despite not being able to foretell investment results yet to come. They make mistakes and lose money periodically. But on balance they do fine.
Unfortunately, not every mistake is so benign. There are investment blunders that actually will jeopardize your financial future. And one of the costliest mistakes you could possibly make is to expect short-term results with your long-term investments.
My experience tells me that people under 40 are great at falling into this trap. And the real danger of this is that they repeat the error over and over again for many years. As a result they squander precious time that otherwise could be used to grow their investments and secure their financial future.
Let me first explain how this mistake manifests itself. Then I'll give you a few useful tools that will help you avoid this error going forward.
The Under-40 Investment Mistake
It's very reasonable for a 40-year-old to expect to live another 40 years. She might need her investments to start generating income by the time she's 60. But she will probably need her money to continue to working over her entire lifespan. My experience tells me that investors who are more seasoned understand this and have an easier time investing long-term.
But younger people struggle with this. I believe this is because many feel they haven't saved enough money for their future. They fear that they are far behind the retirement eight ball. They'll run a financial retirement calculator and determine that they need to accumulate 16 gazillion dollars in order to retire and it rightfully scares them.
How do they respond to this fear? Usually in one of two ways. Some get super aggressive and make very speculative investments. This usually ends up costing them big time as they suffer catastrophic investment losses sooner or later. The other (more likely) approach that younger investors make is they become super conservative. This happens because emotionally they can't tolerate any short-term risk.
I completely understand these two mind-sets. I not only work with people who have to deal with these challenges, I made both those mistakes when I was younger.
I had a young family when I was in my late 30's. My wife and I didn't have much saved at that time and we knew we had to catch up. My bride was so thankful for the little savings we did have that she wasn't prepared to do anything with it other than keep it parked in the bank.
I took the opposite approach. I figured that our only hope was to be aggressive with the money if we wanted to get on track financially. In the end, my argument carried the day -- unfortunately.
I made very speculative moves with our money and we ended up with huge losses. I guess the silver lining was that we didn't have much to lose at the time so it wasn't as costly as it could have been. Fortunately for both my wife and myself, we changed our investment mentality and that shift was been the key to the growth of our portfolio.
What mindset helps people under 40 invest better?
My suggestion is that you approach this methodically. Before you invest, think about when you are going to need your money and over what time period. If you are like most of us, you'll want that money to generate income when you retire of course. But you will also want that income to continue until you and your spouse have gone to that great big retirement home in the sky. That means you have to think long-term.
It's really important to get this one concept though through your head; it doesn't matter what the value of your account is this week, this month or this year. All the matters are what the values are as you tap into the account over many years.
That being the case, it's really easy to eliminate certain options. With low interest bearing accounts, the return is so low that they virtually guarantee retirement failure. Guaranteed deposits may give you short-term security but we've already established that:
A) You don't need short-term security.
B) What you really need is long-term growth and short-term investments aren't designed to provide that.
So this is a non-starter and it leaves us with stocks, bonds and real estate for your long-term growth investments.
For purposes of our discussion, let's focus on the stock/bond alternative. Now it's time to decide how to make these investments. One approach is to speculate. When you do that you take big risks.
Once in a while you'll be right and hit it out of the park. But if you plan on building your investment nest egg on speculation, risk is going to catch up to you. You'll get it wrong far more often than you get it right and you will lose the game.
It's true the some people are great speculators. But most people aren't. If you are in the former camp -- and chances are high that you are -- speculation is a game you really don't want to bet your financial future on.
You can see that by process of elimination, the best approach is to invest using a long-term investment strategy and the facts bear this out. According to JPMorgan, the average annual return on a stock/bond portfolio was 8.9 percent from 1950 through 2012. Of course in any one year speculators could have made as much as 32 percent or lost as much as 15 percent. But over a very long period of time, the averages work in your favor. Since people in their 40s do have a very long time to invest, it just makes sense to ignore short- term results and stay focused on the long-term.