Investing Basics: New to investing? Avoid these seven common mistakes
There are seven key mistakes that investors have been making since the dawn of modern markets, and are likely to repeat them for years to come; being aware of these common errors and taking steps to avoid them can significantly boost your chances of investment success – writes Christian Leeming
Financial education is key to having the ability and understanding to achieve your financial goals.
Not having a plan
‘If you don’t know where you’re going, any road will take you there’ – so, always have a personal investment plan that includes:
Goals and objectives – what are you trying to accomplish? School fees/retirement/world cruise – sure; how much and when?
Risks – what risks are relevant to you or your portfolio? If you are a young investor saving for retirement, you should be able to ride out market volatility; however, inflation – which erodes any long-term portfolio – is a significant risk.
Benchmarks – how will you measure the success of your portfolio?
‘If you don’t know where you’re going, any road will take you there’
Asset allocation – the mixture of investment types you hold – UK shares, international shares, bonds, etc and how you hold them – either directly or in a pooled investment – a fund – or a tracker –ETF. Each investment type comes with its individual risk and return characteristics, and each will perform slightly differently in changing market conditions.
Diversification – investing in different asset classes is the initial layer of diversification, and then you should diversify within each type – eg FTSE 100 stocks or maybe AIM.
A personal investment plan should help you stick to some basic principles and will give you a better chance of success than taking random punts on the ‘next big thing’ the chap in the pub told you about.
When saving for retirement in thirty years’ time even dramatic short term moves in the market should not phase you; even if you are close to retirement, you can still realistically expect to be around for another 15-20 years, and possibly planning to pass some of your wealth on.
If possible try to give yourself as long as possible in pursuit of your goals to avoid having to sell out of an investment when values have fallen.
Taking tips and following financial media
As a long term investor, there should be little other than background information to glean from the many channels delivering noise around stock selection; if anyone really had profitable stock tips, trading advice or a secret formula to make money, would they describe it on TV or sell it to you for a few pounds a month? No – they’d keep Mum and make their millions.
There are a number of places where investors come together to share and compare experiences and ideas – including @diyinvestornet and @muckleonline; spend more time creating – and sticking to – your investment plan and interacting with ‘someone like you’.
Rebalancing is the process of returning your portfolio to its ‘out of the box’ state after market movements have dragged it out of shape; psychologically it can be difficult because it forces you to sell the asset class that is performing well and buy more of your worst-performing asset classes.
‘returning your portfolio to its ‘out of the box’ state after market movements have dragged it out of shape’
The discipline to rebalance is counter-intuitive, but a portfolio allowed to drift with market returns guarantees that asset classes will be over-represented at market peaks and under-represented at market lows – a formula for poor performance; rebalance religiously and reap the long-term rewards.
However much fund managers trumpet the benefits of active management, most of the investment professionals you could entrust with your money underperform the benchmark set for their individual fund.
Active fund managers set out to ‘beat the market’, but often fail; trackers seek to match the performance of an index or sector.
So, if you’re looking for the big bucks, you’d be better off taking your own decisions and trying to time the market, right? Er, no – if the pros can’t get it right, why would you think you can do better?
To avoid the nightmare scenario of buying high and selling low when you are bounced out of an investment, make sure that your portfolio has a good balance of investment types – or maybe let a robo advisor take care of things for you.
‘avoid the nightmare scenario of buying high and selling low when you are bounced out of an investment’
With modest fees and low minimum investments, a robo advisor will ask you about your personal financial objectives, understand how you feel about investment risk, how you would behave if the value of your investments were to fall, and then deliver an instantly diversified investment portfolio.
Passive not active
Studies show that most managers and mutual funds underperform their benchmarks; over the long term, low-cost index tracking funds or ETFs perform better than 65%-75% of actively managed funds.
Exchange Traded Funds have proved to be increasingly popular as the combination of a protracted bull market and low fees have allowed investors to do well over many years; most robo advisors serve up a basket of ETFs as your portfolio.
Active managers will claim that they alone have the ability to take money when markets turn turtle, and certainly the asset managers spend inordinate amounts of money in preserving their brand values of professionalism and trust.
The acid test of their ability will be their performance in a downturn but the fact that the cost of ownership of many funds has been slashed following recent moves to improve fee transparency may render them worthy of another look.
John Bogle, the legendary founder of Vanguard, once said: ‘Hope springs eternal. Indexing is sort of dull. It flies in the face of the American way [that] ‘I can do better.’’
Many investors select asset classes, strategies, managers and funds based on recent strong performance; the feeling of ‘missing out’ has probably led to more bad investment decisions than any other single factor.
However many times we hear that ‘things are different this time’ markets are cyclical; if a particular asset class, strategy or fund has done extremely well for three or four years, the time to invest was three or four years ago.
As smart money moves out, dumb money pours in; stick with your investment plan and rebalance, which is the polar opposite of chasing performance.
At the end of the day……
Investors that recognise and avoid these seven common mistakes give themselves a great advantage in meeting their investment goals; ever more people are joining the FIRE movement in the quest to be Financially Independent, Retired Early.
Most of the solutions are not exciting, but unless you are the type to punt cryptocurrency with your hair on fire, long term investing in pursuit of your financial objectives shouldn’t be a roller coaster ride.
However, armed with this information, your investments are more likely to be profitable; isn’t that why we do it?