What are the four common investment mistakes? Why do investors fall prey to investment pitfalls?
Common investment mistakes you must avoid include adopting overly complex investment models, listening to false oracles, combining companies with flawed synergies, and buying into companies that don’t expense stock options. The mistakes happen because of the competitive and profit-seeking nature of investors. The desire to get ahead and not lose out leads to avoidable and costly mistakes.
Read on to discover more about the four common investment mistakes you must avoid.
Common Investment Mistakes
Given how competitive and profit-seeking financial investment is, it’s prone to developing false wisdom and red herrings. Munger cautions investors against the common investment mistakes made on Wall Street and by other investors.
When investors think about buying and combining businesses, they often point to financial synergies that can result—often through cutting shared overhead costs or expected growth through combining business forces.
Munger is aware that these synergies exist, but finds that many people embellish the synergies that will actually materialize.
Munger and Buffett like simple investment philosophies—buy good businesses with sustainable competitive advantages at low prices. They find mathematically and theory-heavy investment models, like modern portfolio theory and beta, incomprehensible. For example, Munger finds the idea that a stock’s volatility is a measure of risk nonsense.
Munger thinks the same about derivatives, which can have incredibly complex structures and become nearly impossible to do reliable accounting on. Derivatives books are often constructed out of thin air, fanciful thinking, and false profits. He pointed out how derivatives obfuscated the terrible situation at Enron, and in 2003, well before the 2008 financial crisis, he predicted that “there are big troubles to come.”
Munger points out that one of the common investment mistakes people make is to listen to so-called experts that can predict the future. This is foolhardy—people are no better at predicting the future of financial markets than they are at reading tea leaves.
Not Expensing Stock Options
Munger and Buffett both believe issuing stock options must be accounted for as part of expenses. Avoiding this reduces expenses and inflates company earnings, which is why executives like doing it. In the short term, this can raise stock prices, but eventually the finances don’t add up, and confidence in the company plummets along with the stock price. (Shortform note: read this HBR article for a more thorough discussion of why managers falsely believe options shouldn’t be expensed, and why those reasons are foolish.)
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