Sin #1: Holding cash in a retirement account. This one always breaks my heart when I see it from a new investor. Here’s how it goes. You’re young and finally get a job making some money. You keep hearing this funny phrase “Roth IRA”. You know it’s something you probably are going to wish you had done as soon as possible, so you finally get around to opening one. You find a brokerage website, go through all the steps to open your account, link your bank account, and contribute money. PHEW, you did it, you think. You’re done.
NO YOU ARE NOT DONE MISTER. NOT BY A LONG SHOT. Because putting money into a Roth IRA just moves the cash to that account. But then it just SITS THERE DOING NOTHING unless you DO SOMETHING with it. A Roth IRA is just an account (like a checking or a savings account). But after you put money IN the account you need to take another step to BUY the investment you want.
So if you login to your Roth IRA and see money sitting in something called “Core” or “Money Market” or “Cash” or “Settlement Account” then that money is sitting there doing NOTHING. Not growing like it should be. And you’re very naughty because you have committed the first sin of investing. But you will be forgiven if you login and click “buy” or “trade” or “transact” and dump your money in a target date index fund.
Sin #2: This one pains me a little, because I know investing in individual companies can be exciting and can entice new investors to get started. And for that reason I actually think it’s great. Anything that gets people started investing is a good thing.
THAT SAID, I still consider investing more than 10% of your portfolio in individual stocks to be a sin. Here’s why:
The stock market is very “efficient”. That means every publicly traded stock is priced based on the consensus of the sum total of human knowledge. And it’s a zero sum game. For someone to beat the market, someone else has to lose. It’s like everyone is on a seesaw trying to fly to the sky, but we’re all anchored by the pivot in the middle.
When you think to yourself “Hm… Tesla cars are cool, they’re the way of the future so I should buy that stock.” Everyone else ALSO knows that. So that information is “priced in” to the stock. You have to pay SO MUCH MONEY for Tesla stock it suddenly becomes not worth it. (As evidence of this, Tesla is currently LOSING MONEY EVERY YEAR, yet the stock market has decided the company is worth more than Ford, General Motors and Daimler COMBINED).
And you also have to think about what you’re up against: There are companies who employ people full time to do nothing but analyze Tesla stock. They put satellites into space to photograph Tesla factories to count cars coming off the line. They pay former employees hundreds of dollars an hour to learn about Tesla’s strengths and weaknesses. They crunch massive sets of data to predict car buying trends and future growth prospects. All this to answer the simple question “Is Tesla stock going to outperform an index fund”. And even THEY generally don’t beat an index fund. And neither will your hunch.
So if you want to play with individual stocks, keep it to 10% of your contributions. With 90% buy and hold index funds.
Sin #3: I think we all love the idea of picking winners. And we all love jumping on bandwagons. After all, isn’t that why the Yankees have fans?
But being a bandwagon fan in investing can cost you a lot of money. I see it all the time. Someone pulls up a list of investments like they’re looking at a menu at a fancy french restaurant. “Well,” they think, “I clearly want the BEST thing.” So they sort the list by past performance. “Oooh! This inverse triple leveraged Indonesian oil future mutual fund returned 126% last year, I’ll just put all my money there!” But guess what. Maybe last year was a great year for inverse triple leveraged Indonesian oil future mutual funds, but that doesn’t mean next year will be.