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Tomorrow? Who knows? But one constant, say the authors of two new business books, is the real possibility that you will do something to make your portfolio worse. The writers are out to save you from yourself. The better of the two books, “Investment Mistakes Even Smart Investors Make and How to Avoid Them” (McGraw-Hill, $28) is, in essence, a detailed checklist — in the form of short, focused chapters — of what not to do. Larry E. Swedroe, director of research for the Buckingham Family of Financial Services, which manages $3 billion of clients’ money, and RC Balaban, a media specialist at the firm, have created 77 things to guard against in making investment decisions. First, let’s get the nits out of the way. Of the 77 mistakes the authors describe, there are a handful like “following the herd,” not starting to save soon enough, and being too conservative (and being victimized by inflation as a result). These are things you may have heard 873 times. And as the number climbs to 77, the authors come dangerously close a number of times to double-counting. For example, there is a chapter on not believing in luck, followed closely by one warning against winning streaks (as in, just because a mutual fund manager has outperformed the market for three consecutive years doesn’t mean she is guaranteed success in Year 4.). And there is a chapter cautioning about believing “experts” and another about not blindly following market gurus. No matter. A significant number of chapters should at least get you to reconsider your investment strategy. For example, many investors minimize their exposure to real estate investment trusts, figuring that because they own a home, real estate is already represented in their portfolios. “A home is clearly real estate. However, it is very undiversified real estate,” the authors write. “It is undiversified by type. There are many types of real estate: office, warehouse, industry, multifamily, residential, hotel and so on.” In addition, “a home is undiversified by geography.” Another common mistake is buying an index fund and believing that you own equal amounts of the stocks in the index. That is usually not the case. Most indexes are market-cap weighted. That means an individual stock’s representation in the index is based on that stock’s market capitalization as a percentage of the total market cap of all the index’s stocks. The larger the stock’s market capitalization, the greater the percentage of the index fund it will represent. As a result, the authors write, “most investors would be surprised how little exposure a total market fund has to the asset classes of small-cap stocks and value stocks.” Small-cap stocks accounted for just 8.2 percent of the total at the end of 2008, the book says, while the figure for value stocks was only 5.4 percent. The authors are huge fans of buying index funds, but they add that “indexing does not mean that an investor should hold only an S.& P. 500 Index fund or a total stock market fund.” Instead, they say, you should determine how you want your money allocated by asset class — large cap, small cap, international, etc. — and buy index funds for those classes. Here’s another example of a common mistake: Most people know that when it comes to investing, costs matter, but the authors say investors usually don’t consider every possible expense when putting money into a mutual fund. They will look at operating expenses and may forget about taxes — yet some funds are far more tax-efficient than others. And, the authors warn: “The least-understood hidden cost is the cost of cash. The cost of cash occurs when a mutual fund holds a cash position instead of being fully invested in the market. The greater the cash position held, the greater the impact.” A majority of investor mistakes can be summed up by the phrase “try not to shoot yourself in the foot.” And that, as David Dreman shows in his revised and updated “Contrarian Investment Strategies: The Psychological Edge” (Free Press, $30), is a lot harder than it sounds. The good news is that Mr. Dreman, chairman and managing director of Dreman Value Management, which invests more than $5 billion of money for individuals and institutions, points to all kind of work in cognitive and neuropsychology that proves why investing is so darn difficult. For example, “the more we like an investment, the less risk we think it entails even if it is riddled with it.” What follows from this understanding, Mr. Dreman says, is that “the psychology-aware investor holds a superior advantage, not just more theoretical knowledge, but a genuine practical investment edge.” But the bad news is that it takes substantially more than 200 pages before he starts to tell the reader how to use that edge. The early going is all about the psychology; what’s happened in the more than 13 years since the last edition of the book, and why just about everyone else is wrong when it comes to investing. (He is particularly harsh on people who believe in “the efficient market theory,” which suggests that it’s very hard to beat the market over time.) When he does start offering specific investment advice, Mr. Dreman presents a classic value-investing approach. This recommendation is typical: “Buy solid companies currently out of market favor as measured by their low price-to-earnings, low price-to-cash flow, or low price-to-book-value ratios, or by the high yields.” The payoff is fine, but you have to wade through an awful lot of neuroscience and psychology, and people with even a passing understanding of behavioral economics will already know much of it. But taken together with “Investment Mistakes,” this book is a solid reminder that one of the biggest risks to your overall investment health is staring back at you in the mirror.
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