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QUARTERLY INVESTMENT OUTLOOK AND FUND REVIEW

Your Worst Enemy? Yourself, if You've Got These Bad Habits

Overestimating your investment skill and plowing along without a long-term plan are two of the costliest pitfalls.

October 09, 2000|LIZ PULLIAM WESTON | TIMES STAFF WRITER

Matt Matros thought he was a pretty good investor--until recently.

This year's slump in technology shares has whittled his $38,000 stock portfolio by $5,000 and shaken his confidence to boot. The 21-year-old student at USC realized he had developed some bad investing habits, such as buying stocks purely on impulse.

Take, for example, his purchases of Lucent Technologies Inc. and Agilent Technologies Inc. shares in early July after the stocks' prices tumbled.

"I purchased huge chunks of each at 'bargain' prices without properly researching why their prices went down so low," Matros said. "Both companies fell even further, and I decided to just cut my losses."

Overestimating one's investment skill and investing without a long-term plan are two of the worst habits an investor can have, financial planners say. Yet only recently have many investors had to face the idea that their own bad behavior could be hampering their returns.

That's because five years of steadily rising stock pricesthrough 1999, masked the effects of sloppy investment practices, experts say. A generally rising market may reward investors who buy stocks based on rumors, for example, or who chase last year's hot mutual funds without any thought about whether they fit an investment plan.

A more volatile market--such as the one investors are experiencing this year--can brutally punish those same behaviors.

Many investors "have confused the luck of riding the wave--being at the right place at the right time--with the skill of surfing the wave," said Eric Bruck, a fee-only financial planner in Culver City. "They have had to learn the hard way the lessons of humility and sobriety when it comes to this market."

In other words, to make money in today's market, many investors may need to change their evil ways. And they should start with the bad habit that's a direct result of the long-running bull market: overconfidence.

Just as most people rate themselves above-average drivers, many investors overrate their skill at picking investments. A 1997 survey of American Assn. of Individual Investors members found a sample group overestimated their own performance and their ability to beat the market. The investors believed their returns were an average 3.4 percentage points higher than they actually were.

When asked to estimate how well they did relative to market benchmarks, such as the S&P 500, the investors guessed they earned an average 5.11 percentage points better than they actually did.

Bruck believes that few individual investors have a clear notion of their true returns. Instead, many play up their winning investments in their minds, while glossing over their losers.

The conviction that they can beat the market leads many investors to trade too much, which also hurts their performance, contends Terrance Odean, a finance professor at UC Davis who studied trading patterns of discount-brokerage customers.

Odean found that the most active traders between 1991 and 1996 had average annual portfolio returns of 11.4%, compared with 17.9% for the Standard & Poor's 500 index. Investors who traded infrequently had returns averaging 18.5%.

Beardstown Ladies Syndrome

Why would investors persist in such self-destructive behavior? Some may suffer from the Beardstown Ladies syndrome, named after an Illinois investment club that wrote a book about beating the market--then discovered that they had massively overstated their returns because of a simple math error: The club failed to exclude the effect of its own regular cash contributions to the portfolio when calculating returns.

In the same way, investors who see steadily rising balances in their 401(k) accounts may believe they're doing quite well, when in fact much of their gain may be coming straight from their paycheck contributions and their company's matching contribution.

Meier Statman, a finance professor at University of Santa Clara and an expert on investor behavior, believes that if more investors took a cold, hard look at their actual returns, most would give up active trading and opt instead for passive, buy-and-hold investments in mutual funds that mimic indexes of blue-chip stocks, smaller stocks and other broad sectors over time.

Another bad investor habit is investing without a long-term plan. If investors don't know why they're investing, they won't know how much risk they can safely take or how best to divide up a portfolio among various investments, financial advisors say.

Matros admits that setting goals has not been his strong point. He started investing at age 14, buying computer maker Gateway and athletic shoe giant Nike. In the intervening years, he simply kept buying and selling stocks, without trying to figure out his short-term or long-term plans for the money.

Now that his net worth no longer climbs with each trade, he is starting to worry about whether he is properly diversified and whether he should be investing some of his money in lower-risk investments as a safety precaution.

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