Markets Don’t Destroy Wealth.
Investor Behavior Does.
Every market decline creates two kinds of losses. The first is temporary. The second is permanent.
Temporary losses happen because markets fluctuate. Stocks rise and fall. Real estate values move. Interest rates change. Businesses experience good years and bad years. Those fluctuations are normal.
Permanent losses occur when investors react poorly to those fluctuations. History shows that many investors don’t lose money because they picked bad investments. They lose money because they make emotional decisions during periods of uncertainty.
They buy when everyone is optimistic. They sell when everyone is afraid. They abandon long-term plans because of short-term headlines. Then they wonder why their results never seem to match the returns they read about in investment reports.
Over the years, we have watched investors from every income level make the same mistakes. People with seven-figure portfolios and people just getting started.
The mistakes are remarkably consistent. The good news is that once you recognize them, they become easier to avoid. Let’s look at the seven most common mistakes investors make during volatile markets.
Mistake #1: Confusing Diversification with Quantity
Many investors believe they are diversified because they own a lot of things.
- Large-cap stocks
- Small-cap stocks
- International stocks
- REITs
- Bonds
- Rental property
- Technology funds
- Growth funds
- Value funds
It feels diversified. But sometimes it isn’t. The problem is that many investments become highly correlated during periods of stress. (We’ll talk about correlation in depth in the next chapter.)
When fear enters the market, assets that appear unrelated suddenly start moving in the same direction.
Investors discover that owning ten different investments isn’t the same as owning ten independent sources of return. A portfolio containing ten highly correlated assets may be less diversified than a portfolio containing three truly independent assets.
One of the most common conversations I have with investors goes something like this:
“I’m very diversified.”
“What do you own?”
“Several mutual funds, an S&P 500 index fund, a growth fund, a technology fund, and some individual stocks.”
On the surface that sounds diversified. In reality, much of the portfolio may be driven by the same underlying factor: the stock market.
During strong markets, that distinction doesn’t matter very much. During difficult markets, it matters a great deal. The investor discovers that five investments were really one investment wearing five different costumes.
True diversification is not measured by the number of statements arriving in your mailbox. It is measured by how differently your investments behave when uncertainty arrives.
In other words, the goal isn’t to own more investments.
The goal is to own investments that behave differently when markets become difficult. We’ll spend the next several chapters exploring exactly what that means.
Mistake #2: Chasing Yesterday’s Winner
People naturally assume that recent success will continue. When technology stocks soar, investors want technology stocks. When real estate rises, investors want more real estate. Unfortunately, by the time an investment becomes the subject of cocktail-party conversations, much of the easy money has already been made.
Performance chasing creates a perpetual cycle that repeats itself over and over. Buy high. Get excited. Watch performance slow. Become disappointed. Sell. Move to whatever is currently working. Repeat.
Investors end up buying optimism and selling disappointment.
Successful investors typically do the opposite. They focus on long-term fundamentals rather than short-term excitement. They understand that today’s headlines often tell you more about the past than the future.
The challenge is that investment success is highly visible while investment failure is largely invisible, which follows natural human patterns of sharing success and minimizing setbacks. You hear about the neighbor who doubled their money. You rarely hear about the person who lost half of theirs.
Social media has amplified this effect dramatically. Every market cycle creates new investment celebrities. The stories are compelling. The gains seem effortless. What investors don’t see are the years of poor performance that often follow periods of exceptional returns.
Mistake #3: Panic Selling During Declines
This is the most expensive mistake on the list. A market decline creates discomfort. That discomfort creates fear. Fear creates action. The action is usually selling – at the worst time.
The problem is that markets rarely send invitations announcing when they are about to recover. The best days often occur shortly after the worst days. Investors who exit during periods of fear frequently miss the recovery that follows.
Consider what happens psychologically. An investor sees their account fall 20%. Selling creates relief (by releasing dopamine), and the anxiety disappears. The problem is that relief is not the same thing as a good investment decision. The market eventually recovers.
The investor now faces a second emotional challenge: buying back in. Most never do. Instead, they wait for certainty. Unfortunately, certainty usually arrives after prices have already recovered.
Volatility is uncomfortable. But discomfort is not necessarily danger. Those are two very different things.
Consider two investors. Both own the same portfolio; both experience the same market decline. One sells; one stays invested.
Ten years later, their outcomes may be dramatically different. The investments were identical. The behavior was not.
This is one of the most frustrating realities of investing. The portfolio you own matters. The behavior you exhibit often matters more.
Mistake #4: Overconcentration
Every investor has a favorite investment. Sometimes it’s a stock. Sometimes it’s real estate. The investment performs well. Confidence grows. The position becomes larger.
The problem isn’t that concentration never works. The problem is that nobody knows in advance which concentrated bets will succeed and which will fail. History is filled with examples of companies, industries, and markets that appeared unstoppable until they weren’t.
Diversification can feel boring. Concentration can feel exciting. But excitement is not usually the primary goal of investing—financial independence is. One of the most effective ways to protect wealth is making sure no single investment can seriously damage your financial future.
Some of the wealthiest people in America became wealthy through concentration. What we don’t see are the countless individuals who concentrated their wealth in a single company, industry, or investment and never recovered from the outcome.
Survivorship bias causes us to study the winners while ignoring the much larger group of unsuccessful attempts. The stories of extraordinary success are memorable. The stories of catastrophic concentration are often forgotten.
Mistake #5: Ignoring Liquidity
Many investors spend tremendous amounts of time evaluating returns. Very few spend enough time evaluating liquidity.
Liquidity simply means how easily you can access your money.
Every investment exists somewhere on a liquidity spectrum. At one end is cash. At the other end are investments that may require months or years before capital can be accessed. Neither extreme is automatically good or bad.
The key is matching the investment to the purpose. Problems arise when investors place short-term money into long-term investments.
Then life happens. A job loss. A business opportunity. A health issue. An unexpected expense. Suddenly the investor needs money that isn’t readily available. Liquidity is rarely important until the moment it becomes extremely important.
The best investors plan for that possibility in advance. One lesson repeated itself throughout my career in real estate. Investors rarely ask about liquidity during good times. They ask about it when circumstances change.
Sometimes it is an unexpected challenge. Sometimes it is an unexpected opportunity. In both cases, access to capital suddenly becomes extremely important.
The best investment in the world can become a poor investment if it forces you to sell at the wrong time simply because cash is unavailable elsewhere.
Mistake #6: Letting Financial Media Drive Decisions
Financial media has one job: Capture attention.
Your job as an investor is completely different: Build wealth.
Those goals are not always aligned. Television, websites, and social media are designed to emphasize urgency. Breaking news. “Expert” predictions. The message is often the same: Something important is happening right now. You should be paying attention (so we can have the ratings).
The reality is that most successful investors become wealthy through a series of decisions made over years or decades—Not hours.
The average investor consumes far more financial news than necessary and spends far less time evaluating the quality of their overall plan. A good investment strategy should still make sense even after the television is turned off.
Imagine if weather forecasters were evaluated the same way financial commentators are. Every day they would predict hurricanes, tornadoes, floods, and blizzards. Most of the predictions would never happen. Yet they would return the next day and make another dramatic forecast.
Financial media often operates under a similar incentive structure. Predictions generate attention. Attention generates advertising revenue. Calm, disciplined investing is rarely exciting television.
Mistake #7: Investing in Things You Don’t Understand
Perhaps the most dangerous words in investing are: “Everyone else is doing it.” Every market cycle produces investments that seem impossible to ignore.
Friends are making money. Social media is filled with success stories. The pressure builds.
People invest before understanding:
- How the investment works
- What drives returns
- What could go wrong
- How long capital may be tied up
- How the investment fits within their overall portfolio
When things go well, understanding appears unnecessary. When things go poorly, understanding becomes essential. A simple rule can prevent many investment mistakes.
Never invest in something you cannot explain clearly to another intelligent person.
If you cannot explain how it works, you probably don’t understand it well enough yet. There is nothing wrong with saying, “I don’t understand this investment well enough yet.” In fact, that may be one of the most intelligent statements an investor can make.
Every successful investor has passed on opportunities. Every successful investor has watched other people make money in investments they chose not to pursue. Discipline requires accepting that no one can participate in every opportunity.
The goal is not to own everything. The goal is to own enough investments that you understand well enough to stay committed to them during both good markets and bad ones.
The Common Thread
At first glance, these seven mistakes seem unrelated. But they all stem from the same source: Human behavior.
Investing is often portrayed as a math problem.
In reality, it is frequently a behavioral problem. Most investors already know they shouldn’t panic. They know they shouldn’t chase performance. Yet these mistakes continue to happen.
Why? Because fear and greed are powerful forces. Especially during periods of uncertainty.
The investors who succeed over long periods are not necessarily the smartest. They are often the most disciplined. They build systems and portfolios that help them make good decisions when emotions are running high.
Our Investor Relations team has set aside some time for you if you would like to see if our MTI is right for you. Go to IrontonCapital.com/icanalysis to choose your best time for your free portfolio analysis.
