“The first rule of an investment is don't lose [money]. And the second rule of an investment is don't forget the first rule. And that's all the rules there are.” — Warren Buffett

Having a millionaire mindset is about making money and keeping it. Unfortunately, just as there are tried and true ways to build your wealth, there are also tried and true ways to lose your wealth. Once you know these “wealth killers,” you can then take steps to avoid them. Here are 7 of the biggest wealth killers.

1. Loss aversion

We all know that we should step in and sell when an investment goes below a critical level, but it is hard to do in practice. This is because we all suffer from the cognitive bias of loss aversion. That is, when an investment crashes, the idea of selling the investment and realizing a loss is more painful to us than letting the investment fall further. Our emotions get in the way of a good decision.

The concept of “loss aversion” (also known as “prospect theory”) was introduced to investors by behavioral scientists Daniel Kahneman and Amos Tversky. They showed that investors behave differently depending on whether there is an expected gain or loss. While investors overestimate the benefits of an investment with a high expected payoff, they also overestimate the pain of an expected loss.

Loss aversion in stock trading can be overcome through the use of stop-loss orders. These are open orders that will sell your stock when it falls below a specified level. This can be a fixed price or a percentage fall. Most stock trading platforms offer stop-loss orders.

With other types of assets, where stop-loss orders are not available, you can break the bias by reframing the loss. Step back and compare the loss against the size of your whole portfolio or compare the loss against the worst-case scenario if you do nothing.

2. Staying on the sidelines too long

During a bear market, it is wise to retreat to defensive stocks and cash. However, too many investors take too long to re-enter the market and thus miss most of the gains from the upswing.

Missing out on the best days in a rally can really dent your long-term returns. For example, according to our calculations*, if someone had invested CHF 10’000 in the Swiss Stock Market Index (SSMI) 20 years ago (on January 1, 2003) but missed out on the top ten days of returns, they would have made around 46.8% less by January 1, 2023, than if they had stayed in the market for those ten days.

The difference between holding shares regardless vs. missing out on 10 best days in the market from 2003 through 2023 on the basis of SSMI

* The calculations were made using the Swiss Stock Market Index (SSMI) as the Swiss stock market.

Unless you are retiring soon and need to preserve your short-term wealth, it is often better to simply stay in the market rather than try to time it.

3. Being swept up with the herd

Humans aren’t computers, we are herd animals. When a crowd of people acts or thinks a certain way, it is hard for individuals to stand against them. And the bigger the crowd, the harder it is to resist. Groupthink is like the tide.

In investing, it can be easy to get swept up in the euphoria of a bubble or to succumb to market panic despite the fundamentals of your investments.

The key problem is that the herd creates its own self-fulfilling reality. For example, when the herd became convinced that Meta Platforms (Facebook) had entered a death spiral, the stock price fell from above USD 300 in January 2022 to below USD 90 in November of the same year. However, when Mark Zuckerberg began to cut costs, the herd remembered the still large amounts of advertising revenue Meta makes, and now the stock price has returned to above USD 220.

To stand against herd mentality, you need to understand the financial fundamentals of an investment and be able to compare your valuation against what the herd is saying. You can also create trading rules based on fundamentals rather than relying too much on movements in the share price.

“If everyone is thinking alike, then somebody isn't thinking.” — George S. Patton, US General during WW2

4. Belief that you can predict the market

It is wise to understand the fundamentals of your investments and to even build financial models, but don’t fall into the trap of thinking you can predict the market. Even the best investors get it wrong.

The problem is that the market is very complex with huge numbers of variables to take into account. On top of a stock’s fundamentals, there are the actions of management and competitors, the biases of traders, and the underlying economic and financial conditions, among other factors.

Then there is noise. There is so much information available and so much price volatility that it is hard to find statistical relationships between price movements and other variables. Investments have a low-signal-to-noise ratio, which makes accurate prediction difficult.

However, the solution is not to throw out your models and fundamental analyses but to use them with humility. Use them as a guide rather than as gospel.

“The daily blips of the market are, in fact, noise – noise that is very difficult for most investors to tune out.” — Seth Klarman

5. Inflation

Investors can be forgiven for forgetting about the dangers of inflation given we haven’t seen such high levels of inflation for over 40 years.

Inflation eats into the nominal returns of your investments, reducing the real value of your returns. While your certificate of deposit was providing a 3% real return when inflation was low, those returns may now be negative in real terms because of high inflation.

The antidote for high inflation is to invest in assets whose value moves with inflation. This includes commodities and real estate. Otherwise, you need to raise the bar on your minimum required return.

6. The wrong amount of debt

Debt is not bad, but too much will crush you. Likewise, if you have too little then you are missing out on the power of leveraging.

Debt allows you to buy that house you could not otherwise afford and to increase your ability to invest. However, rising interest rates are a good reminder to conduct a personal stress test, to make sure that your debt servicing does not reach a level beyond your ability to pay.

“It’s not debt per say that overwhelms an individual corporation or country. Rather it is a continuous increase in debt in relation to income that causes trouble.” – Warren Buffett

7. Bad tax planning

One of the dirty secrets of the ultra-wealthy is that they don’t tend to pay much in taxes. This is because they use the best advice to minimize their tax in accordance with the laws.

In contrast, many investors invest little in their tax preparation and strategies. They may even feel reluctant to “game the system”. However, the government does not care if you pay too much in taxes and they will only penalize you if you are actually evading tax. In between these two points, there are large tax savings to be had.

Common mistakes in tax planning include not taking advantage of tax incentives for retirement. For example, in Switzerland, you can reduce your taxable income by the deposits in your 3a pension. Another common mistake is not choosing the best legal structures for a company or for preserving wealth for future generations. Once you choose the wrong legal structure, it is often prohibitively expensive to fix.

Final thoughts

These are only the top 7 wealth killers, in reality, there are so many more of them. The best way to protect and grow your wealth is to keep improving your financial literacy. Use knowledge to light your way forward. You may not be able to afford the many advisors of billionaires, but you can take advantage of the amazing amount of information available to you.

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