Top five investment mistakes
These five common investment mistakes can cost you, and the impact will worsen over time unless they’re corrected. The fixes include making a plan, refining it over time and sticking to it, frequently reviewing investments, and taking a long-term view. But what are the mistakes?
It has been a turbulent decade for financial markets, with boom followed by the bust of the financial crisis and the shaky recovery since. This year has seen a fresh outbreak of volatility, which was heightened by the UK’s vote to ‘Brexit’ the EU. However, a good investor should hardly have noticed. That’s because they’re in it for the long-term and aren’t influenced by short-term fluctuations in the financial markets, or mass shifts in sentiment.
By following a simple set of rules and avoiding the common pitfalls, anyone can become a more successful investor in this way.
So what are those pitfalls? Here are five common mistakes that investors make:
Trying to time the market
Over the past 20 years the US stock market has produced annualised returns averaging 8.19% – yet private investors achieved returns of only 4.67%. They tended to ‘buy high’ and ‘sell low’ instead of the other way round, and miss out on strong days in the market through not being invested. If your investments had tracked the MSCI World Index between 2005 and 2015 you would be up 60%. But if you had managed to miss the best 10 days in those 10 years, you would be down 5%.
When you have sums to invest, don’t try and second-guess the market by committing it all at the same time to the same assets. If the unexpected happens, you could be caught with all your eggs in one basket. Ignore short-term fluctuations, focus on the long-term, and make sure you’re spreading your portfolio.
Following the herd
A recent survey of investment professionals highlighted the herd instinct, or ‘groupthink’, as the biggest challenge, says Colin McLean, co-founder of SVM Asset Management. ‘That drive for conformity can make us slow to reappraise information, to think originally or even to take sufficient portfolio risk. Crowds can give false comfort.’
You should always understand why you are holding an investment, Mr McLean says. ‘How often do analysts tell us that a CEO is respected, the company is quality, and they have conviction in the share as a long-term core holding based on fundamental analysis? It sounds good, but investors need to dig deeper.’
Rob Morgan, analyst at Charles Stanley, warns: ‘Most nightmarish investments I have seen have stemmed from supposedly ‘hot’ sectors that subsequently failed to live up to the hype. A sector that proclaims to be “the next big thing” is probably as big a red flag as you can get that your investment will come back to haunt you.’
Getting spooked by headlines
The stock market is only front page news or a TV sensation when it is crashing or hitting record highs. But headlines can be powerful and these are the danger points for investors, who may make the mistake getting market timing all wrong.
Duncan Carmichael-Jack, partner at Vestra Wealth, says: ‘Investors also need to bear in mind that during some periods, like the summer, company information on trading is much reduced and headlines instead focus on geo-politics. Sparse data can create false signals and there is limited new fundamental information to merit any change in strategy.’
Falling in love with companies or sectors can be dangerous. You get emotionally attached, and end up with an unbalanced portfolio with not enough diversification. That increases your risks.
John Langrish, head of investments at James Hambro & Partners, says: ‘People go for all associated companies simply because in the past one has done well for them. If you concentrate your money in one sector, you run the risk of being hit hard when there is a banking or commodity crisis, or suffering heavily when a country has a prolonged spell of poor performance, as happened to investors in Japan in the 1990s.’
A related error is holding on to failing investments. A successful investor detaches emotionally from his or her investments, recognises mistakes and corrects and rebalances the portfolio to maximise success.
Lee Goggin, co-founder of findawealthmanager.com, says: ‘Fear of admitting you were wrong can also cause losses to be more extreme than they need to be. Investors can often ‘ride a stock down’ when it is plummeting rather than recognise their mistake, get out fast and limit their losses.’
Patrick Connolly, of Chase de Vere, the independent financial adviser, adds: ‘The big danger with not rebalancing is that it can change the risk profile of your portfolio so that you can end up taking too much or too little risk.’
Investing needs discipline. An investor should make a plan and stick with it, refining it and rebalancing the portfolio where necessary. Don’t try and read markets, and don’t get emotional with your investments.
‘It’s a natural human bias to see patterns in everything,’ says Colin McLean. ‘We create stories and linkages that reassure us we can interpret events. It can encourage investors to jump aboard trends, and buy into shares too late. That may give the illusion of controlling events that are actually more random than we think. Having an investment checklist or other analysis discipline can help to reduce the emotional appeal of patterns.’
We also tend to get stuck in the past, through what psychologists call ‘anchoring’. That means we base our judgements on false insights about a sector, or macro-economics, or a perceived investment ‘theme’.
Chris Justham at wealth manager 7IM says: ‘If investors are not careful, this can lead to decisions being made on what may be irrelevant or out of date information. ‘