8 reasons investors fail (and how to prevail)

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I founded my investment research company, Validea.com, over a decade ago based on the simple premise that investors could learn from those individuals (Warren Buffett, Peter Lynch, Ben Graham and others) who had proven to be successful in the past.

Through my experiences I have been fortunate enough to talk to hundreds of investors over the years, and I've found that many smart and successful people make some critical mistakes when it comes to the stock market. Those mistakes can have a dramatic impact on their chances for solid long-term performance.

However, I've also learned that these mistakes are avoidable. The first step is to understand what these mistakes are. The next step is to make improvements in your overall investment game plan that put the kibosh on these common investor mishaps.

1. Chasing performance

If you see an ad promoting eye-popping performance that looks too good to be true, it probably is. Still, investors often chase hot-performing funds and strategies only to find that they are getting in at the top after most of the returns have been realized.

If you see a fund or strategy that has produced great returns, try to understand what drove those returns and whether that performance is a one-time, or lucky, occurrence. Is the manager, strategy or system unique in a way that gives that performance a good chance to continue? Ask those questions before you jump in feet first.

2. Market timing (when you can't hit 75%)

Trying to determine the market's short-term movements, and moving funds in and out of the market based on those predictions, is a nearly impossible game.

As William Sharpe, the Nobel laureate and Stanford business professor, once pointed out, you need to be correct about 75% of the time with market-timing decisions in order to outperform someone who stayed invested in the market.

Remember, getting out of the market is only half the battle -- you also need to know when to get back in. The market's biggest gains come on a disproportionately small number of days, and if you're sitting on the sidelines on some of those days, you'll have a lot of ground to make up with your other guesses. The bottom line: Trying to time won't work for most investors, so don't do it.

3. Investing emotionally

Our emotions and biases can be our worst enemy, especially when it comes to investing. Warren Buffett once wrote: "Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ. … What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework."

If you find yourself on an emotional roller-coaster ride when it comes to investing, the first important step is to acknowledge that your emotions might be getting the best of you and find ways to overcome them. One way that I accomplish this is by following a systematic approach.

I don't allow my emotions to cloud my judgment, because I rely solely on the fundamentals. This approach allows me to become dispassionate about the stocks that I own and when to buy and sell.

If you can develop hard-and-fast rules for your own investment strategy, and stay committed to those rules, you can overcome the psychological hurdles that hurt long-term performance.

4. Ignoring the fact stocks are risky (in the short run)

Peter Lynch, the famous mutual-fund manager, once said if you have one- or two-year time horizon, then investing in the stock market is like going to the casino and putting your money on red or black on the roulette wheel.

The reason stocks offer great long-term returns is because they are risky and have a potential for loss -- particularly in the short run. There will always be volatility -- and your losses are never permanent until you make them permanent. The longer your holding period, the less variability (and potential loss) you are exposed to.

5. Getting scared away from stocks

Because stocks are risky in the short run, it's important to make sure you are properly diversified -- not only with your equity portfolio, but also in terms of asset allocation. If the market's recent volatility has you asking yourself whether or not you want to be in the market at all, then a good first step is to look at your portfolio's holdings.

Do you have varying asset classes represented -- bonds, real estate, even cash? If the answer is no, than take the opportunity to do some housecleaning and consider allocating pieces of your portfolio into asset classes that are less correlated with the overall stock market.

Even though all of the gurus I follow invest mostly in stocks, I am willing to bet that none of them would disagree with this advice. Diversification will help your overall portfolio weather the tough times when your stocks are showing lots of volatility.

Peter Lynch once said the worst thing long-term investors can do is get scared out of stocks, and having a diversified portfolio can help you stay committed to your equity investment strategy when stocks struggle.

6. Worrying over day-to-day moves

In an interview with Chuck Jaffe, I once heard Vanguard founder John Bogle say that he looks at his portfolio's performance only about once a year.

Of course, we're not all John Bogle, but let's take this point one step further. If you're the type of person that is checking your portfolio's performance every day (or multiple times a day), you're probably checking it too much. You'll be tempted to react to random, short-term moves and trends. I recommend checking your investment portfolio at most once a month, or maybe even once a quarter, to avoid making any knee-jerk reactions.

7. Losing patience or discipline

James O'Shaughnessy and Joel Greenblatt are two investors whom I highly admire. Each developed sensible quantitative strategies and back tested them over long periods of time to show investors that simple strategies can outperform the market.

What O'Shaughnessy and Greenblatt also pointed out, though, is that these strategies don't always work. In fact, they can go through periods of two or even three years in which they don't appear to be working. As an investor, you need to realize that even the best strategies can go through periods of underperformance.

It's that underperformance that shakes most investors out, allowing those who stay the course to get strong stocks at lower prices). As O'Shaughnessy has said, "Finding exploitable investment opportunities … requires the ability to consistently, patiently, and slavishly stick with a strategy, even when it's performing poorly relative to other methods. … Disciplined implementation of active strategies is the key to performance."

Mark Hulbert, founder of The Hulbert Financial Digest is another person I have a lot of respect for. Hulbert has been tracking investment newsletter performance for more than 25 years, and he has said that what separates the best-performing newsletters from the pack is that they all have a strategy, and stick with that strategy through both good and bad times.

8. Not believing in your strategy and your picks

If you don't believe in a stock you are investing in, the portfolio manager you have working for you or the investment strategy you're following, chances are you will not be able achieve the best long-term results.

Any good company, mutual fund or strategy will have periods of underperformance. If you don't believe that in what you are investing in, you will most likely abandon it in tough times.

More guts than brains

Succeeding in the stock market is hard -- but not always for the reasons you'd assume.

While many people think you need to be a brilliant financial mind or have developed some intricate, highly complex strategy to make money in stocks, the reality is that you don't have to be a rocket scientist to beat the market. The common pitfalls I've outlined above aren't problems that occur because investors lack intellect, intelligence, and financial or mathematical acumen; they occur because most investors allow their emotions and short-term anxieties to dictate their decisions, rather than sticking to a proven long-term plan.

As Peter Lynch has said, stomach is the key organ when it comes to stock investing -- not the brain. You have enough brainpower to succeed in stocks; if you want to avoid the mistakes I've discussed here, however, you're going to have to have the intestinal fortitude to shrug off any short-term market angst and stay focused on long-term results.