Besides my podcast interviews, I have also received about 500 written stories on the topic of My Worst Investment Ever. I’ve done a lot of work to analyze and categorize all these interviews and stories to determine the ways investors lose money. We know that to win in investing you must take risk, but to win BIG, you must reduce it! I’ve found that there are six ways you will lose your money:
- Failed to do their own research
- Failed to properly assess risk
- Were driven by emotion or flawed thinking
- Misplaced trust
- Failed to monitor their investment
- Invested in a start-up company
1. Failed to do their own research
This mistake is all about failing to do the work. Investing, like any other profession is hard. People make this mistake when they rely on the research of others, rather than their own. This mistake also occurs when people are not open to the advice of professionals. Investors also forget that “past performance is no guarantee of future results.” Finally, remember that life is simple. Don’t let your investments get complicated, untangle them before this mistake creates “Gordian Knot.”
2. Failed to properly assess risk
It is common for people to obsess on future returns and hardly consider the risks. This leads to them to take on too much risk. The most common risk reduction mistake is failing to diversify. Investors tend to go “all in” to an investment rather than starting with a small position and growing it. The next mistake is that they fail to set an exit strategy-what to do when things go wrong (or right). Without an exit strategy, they freeze when things go wrong. Long-term investors often deplore a stop-loss exit strategy, while stock market traders depend on it every day. You should consider a stop-loss. Finally, investors buy illiquid investments that they cannot sell without impacting the price.
3. Were driven by emotion or flawed thinking
Investment losses and gains trigger dopamine releases in your brain. Behavioral finance has identified a myriad of emotion and thinking based errors. The pull of greed and the push of fear can cause you to make the wrong investment or to invest at the wrong time. Overconfidence is a common mistake from “Worst Investment Ever” stories of loss. Another is when people grow attached to an investment, based on prior gains or losses from it. It is common for people to look back in despair. They get disappointed at that investment they should have made or the one they sold too early.
4. Misplaced trust
Trust is the most important thing in life, without it you have nothing. Many people get tempted into investing with people they know nothing about. Beware of people who spend their lives learning to manipulate others out of their money. Also, investing with friends rarely goes well and the trust you thought you had may evaporate. Lastly, people make the mistake of investing in an investment structure that is untrustworthy.
5. Failed to monitor their investment
You cannot expect anyone to take a greater interest in your investments than you. People make a mistake when they don’t insist that the people they are investing with keep them up to date. It must also be clear that this monitoring should be heightened when things are not going well.
6. Invested in a start-up company
There are many stories of loss from investing in a start-up company. Why? Well because most new businesses fail. Pick a number, how about 50% fail within five years? And the rate is higher if we exclude survivors that never grow big enough to provide for more than the owner. A common mistake made when in investing in start-ups when you are the sole source of funds. So, when things go bad (as they often will), there is no one else to turn to. This forces you to add more funds or else. Another problem with start-ups is that they lack financial controls. Start-ups also fail because they lack a clear business plan. They often have no real competitive advantage. Another common problem is that they lack a clear leader. Finally, they often fail when founders expect that an idea that worked in another country or region will work in theirs.