Long-term investing is a proven strategy to build wealth, and it is a lot more powerful than many investors realize. However, whether you are brand new to investing or a seasoned pro, there are seven terrible mistakes (deadly sins) that can easily prevent you from achieving success.
Before getting into the details of the seven deadly sins, here is a fun analogy from famous value investor, Warren Buffett, about the benefits of long-term investing:
“Someone’s sitting in the shade today because someone planted a tree a long time ago.”
Without further ado, here are the seven deadly sins of long-term investing.
7. Cash Hoarding
Having too much cash in the bank...
You might think you can NEVER have too much cash in the bank, but you sure can if it's not working for you. Considering interest rates are so low (thanks to the Fed, and because checking and savings accounts offer very low interest rates anyway), it is an incredibly dangerous practice to keep too much cash in your bank account. Specifically, it can ruin your chances for long-term success because of the extreme opportunity costs. For example, if you’d like to live comfortably in retirement someday, you’re probably going to need to move some of that money from cash into long-term investments. Don’t believe me? Here is a look at the value of $100,000 that sits in cash in your bank account for 20 years, versus the value of $100,000 in the stock market:
Assuming an 8% total return for stocks and the one quarter of 1% interest in a checking account (if you're lucky), twenty years from now, would you rather have $105,121 or $466,096? And remember, after inflation, you won’t be able to buy nearly as much with $100,000 in 20 years as you could today. If you ever want to live comfortably in retirement (or even get to retirement, for that matter), you’re probably going to need to move some of your cash into long-term investments. For example, a low-cost diversified portfolio of long-term stock investments is a lot less risky than cash over the long-term after you factor in inflation and the huge opportunity costs.
Still not convinced you can have too much cash? A common argument is that investors keep cash on hand to "buy, buy, buy" if the market crashes. Sounds like market timing to us. No one has a working crystal ball, and market timing is a proven strategy for failure. Your chances for success are far better off if you don't keep too much cash in your bank account.
6. Forced Selling
Ignoring your liquidity needs
It’s important to put your cash to work for you, but it’s also critically important to leave enough cash in your bank account so you have it when you need it. For example, if you need a down payment for a house next spring, or you want to pay your kid’s tuition in the fall, you’re better off not putting that money into long-term stocks because you need it in the near-term. The stock market goes up in the long-term, but it’s volatile in the short-term, and you don’t want to be forced to sell your long-term investments when the price is bad. For example, during the financial crisis from late 2007 through early 2009, the stock market lost half its value, but then regained it all (and a lot more) over the following years. If you’d have sold at the bottom then you’d have missed out on those great returns (and a lot of money) during the rebound. If you need your money in the near-term, don’t invest it for the long-term. Here is another colorful quote from Warren Buffett to explain:
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”
5. Yield Chasing
At Blue Harbinger, we often focus on income-investing, however few things frustrate us more than when an investor assumes an investment with a higher yield must be better than an investment with a lower yield. We call this “yield chasing” and it is a bad idea.
Investments with very high yields are often a red flag, and an indication of a company in distress. It can signal a dividend cut on the horizon and potentially even a bankruptcy for the company. Rather than chasing the highest yields, investors should focus on the best yields. For example, we like companies with safe, well-covered yields, and the potential to increase the dividend in the future. Also, critically important, not all income needs to be generated from dividend or interest payments. Prudently selling some of your investment to generate income can dramatically reduce risks, and it can lead to better investment and tax decisions (more on taxes in the next section).
4. Disrespecting Uncle Sam
Ignoring Tax Consequences...
Aside from the obvious (like going to jail for not paying your taxes) there are huge tax mistakes that long-term investors often make that can prevent them for achieving the success they want. For your reference, we’ve listed and described several big tax mistakes that many long-term investors often make.
Choosing a Roth account when you’re better off in a traditional account. The government has set up tax qualified accounts to make saving for retirement easier. However, if you select the wrong type, you are hurting yourself significantly over the long-term. For example, a traditional IRA (individual retirement account) allows you to save for retirement on a pre-tax basis. This way, you’re money will grow faster, and you won’t pay taxes until you retire. On the other hand, a Roth IRA lets you pay taxes up front instead of during retirement. A mistake some investors make is to contribute to a Roth IRA now (instead of a traditional IRA) when they are in the highest tax bracket, and they’ll likely be in a lower tax bracket during retirement. You’re effectively paying more tax dollars than you need to by selecting the wrong type of IRA.
Generating short-term gains without considering the tax consequences is another terrible mistake. Often times investors trade in and out of positions on a short-term basis, and then brag at the end of the year that