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Chapter 1. Other People's Problems > Effect of a Blunder

Effect of a Blunder

Experiencing an investment blunder can devastate your wealth. When you push too hard for top performance, you open the door for the possibility of a blunder. Investors who push too hard end up getting too aggressive and taking too much risk. Ultimately, the consequence of taking too much risk is to experience a problem that devastates your portfolio. You can easily lose 50%, 60%, even 90% of your portfolio. This book is full of examples of both professional and individual investors experiencing this exact problem.

A typical scenario is that an investor has a strong desire to outperform his or her colleagues, neighbors, the pros, and the market. In the pursuit of these riches, he or she falls into a psychological or emotional trap and loses a good deal of wealth. Figure 1.1 shows the experiences of many investors. First, let us assume that your household has a portfolio of $50,000 (including retirement plans) and can contribute to it at a pace of $6,000 per year for the next 20 years. The market earns 12% per year. You can earn the market return by indexing, a strategy discussed in Chapter 15, “Investing to Win and Avoid the Blunders.” Or you can try to beat the market and earn 14% per year. Figure 1.1 shows the building of wealth for the market and for our dream of beating the market. If you earn the market return, you will end up with $915,000. If you beat the market by 2% per year, then you will have $1,233,000 at the end of 20 years. The difference is substantial. Our greed and our overconfidence tell us to go for the 14% return.


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