Despite what some might have you believe, investing is far from a science. But that doesn’t mean there aren’t bad approaches. Novice investors will inevitably make mistakes, and some professionals are little better.
Here are our top ten investor mistakes:
Failing to plan
Too many investors start buying stock without an objective. Beating the market and getting rich quick rarely happens and isn’t a solid plan.
Identify your goals. Are you looking to grow capital to save for retirement? To pay your daughter’s tuition fees? A clear target will determine how much money you invest, and how often. How long term your strategy and how much risk is required.
Investing your own capital can be fraught. Your character matters just as much as your goals. You need to assess your comfort level and choose assets and funds to match.
Diversification is essential for minimising risk. Spreading your investment across a range of securities – different companies, different sectors and different countries – will make you much less susceptible to short-term market fluctuations. If one company or sector is falling, another may be on the way up.
Diversification isn’t flashy and won’t necessarily make headline returns. But it will help you not lose your capital in one go.
Overconfidence in fund managers
It’s easy to fall for a star fund manager. Investing in a mutual fund with a high-performer at the helm is a good idea, but not an excuse to get complacent.
Fund performance varies year on year, and often gets worse over time – so you need to keep an eye on how well the fund is doing. Fund managers also move, so at the very least pay attention to their movements.
Following the crowd
Everyone else is doing it, but that doesn’t make it right. If everyone buys shares in Apple, chances are that stock will get overpriced and you’ll lose out when it crashes. Conversely, if you join a run on tumbling stock, you may miss the recovery.
Think of the dot-com boom. And then think about how much money Warren Buffett made by sitting it out.
Obsessing over your portfolio
Too much information can be a dangerous thing. Checking the status of your securities every day can very easily lead to short-term, panic decisions that pull you away from your investment plan. Better to check on a longer, regular basis and pay attention to trends rather than peaks and troughs.
It also won’t do any favours for your blood pressure.
Not reviewing your portfolio
Just as dangerous is not reviewing your portfolio enough – a particular risk if it’s entrusted to a professional manager.
Your assets need to be rebalanced every so often to ensure your investments still reflect your investment plan. This can mean counter-intuitively selling some of your best performing stock in exchange for worse performers, but it may be essential for minimising risk in the long run.
If your assets are professionally managed, reviewing your portfolio is still important. You need to keep an eye on how well it’s being managed, and if the investments remain in line with your goals.
Timing the market
‘Timing the market’ is predicting market cycles and attempting to exploit them for profit by buying or selling stock as appropriate.
This isn’t a mistake per se. Plenty of people do so very profitably. However, there are many more who claim it’s impossible, and that a longer-term approach will win out: a view backed by a number of studies.
Market timing is a risky strategy that can reap great rewards. But more often than not it’s a costly mistake.
Overlooking index funds
The glory may lie with actively managed funds, but passively investing in an index fund often delivers better returns. Active funds are regularly outperformed by passive tracker index funds.
An index fund is a mutual based on a market index like the S&P 500 or FTSE 100. The fund mirrors the index – so if 8% of the S&P 500 is in BP, 8% of the fund’s equity will be in BP. You win or lose on the movement of the market rather than individual assets. Index funds are diverse by default, so are relatively low risk.
Passive funds also have ultra-low management fees: as little as 0.2% in some cases. As such, they needn’t yield the same returns as active funds to turn a profit.
Common wisdom is to invest only what you can afford to lose. Buying stock on margin is risky, as is ploughing your entire nest egg into Facebook.
This is good advice. However, the more money you put in, the more you stand to make. And small amounts add up over a long period. For example: if you have £10,000 invested and add £500 per month as opposed to £250, assuming an 8% return, you will have close to an extra £1,000,000.
Many investors choose to make regular contributions to their portfolio – perhaps a fixed proportion of income – maintaining capital growth but leaving the household budget safe.
Paying too many fees
Every fee comes out of your profit and increases how well your investments need to perform to cover management costs.
Many mutual funds have a one-time sales charge of up to 5.75% and an annual expense ratio of 1.5-2% (or more) in addition to a wrap fee of 1-2%. If investing independently of a fund, you pay a sales fee every time you buy and sell.
Sticking to low-cost mutual funds, fund supermarkets and discount brokers (and minimising trades) can dramatically reduce your expenses.
Avoiding the mistakes on this list by no means guarantees success. But it should go some way towards avoiding failure.