Common investment errors can hit your portfolio hard
Investors who sold out of equities after Brexit and again just after the Trump election victory quite possibly lost money last year, even though the big stock market indices turned in strong gains. Turns out they fell into one of the most common investment pitfalls. Here’s a quick guide to three of the most common investing mistakes and what you can do to avoid them in 2017.
Mistake #1: Timing the market
Many investors have an unfounded confidence in their ability to buy and sell an investment at precisely the right time to maximize profit and portfolio performance. In practice, this is almost impossible to achieve consistently.
Attempting to “time the market” leads to frequent trading, incurring trading costs on both the buy and sell side. In addition, because no one has a crystal ball, chances are good you’ll miss both the top and the bottom. Overall, you’ll have incurred trading commissions, and you’ll typically be no further ahead than if you had stuck with a disciplined price-target strategy.
If you pursue a market timing when you invest in mutual funds or exchange-traded funds (ETFs), you’re likely to fare even worse, underperforming or even negating fund performance.
Good investing is about planning. Work with your adviser to develop an asset allocation strategy based on an understanding of your financial objectives and your tolerance for risk. Choose how much money you want to allocate to each of safety, income, and growth assets within your portfolio. Then populate each of these allocations with appropriately selected and researched investments. You should monitor monthly, but there should be no reason to trade in and out of your chosen investments if you’ve screened, researched, and selected your investments properly. Build your portfolio, have the confidence to stick with it, and rebalance in a year’s time.
Mistake #2: Wishful thinking
Novice investors will often buy an investment because it has recently gone up in price, in the expectation that it will go up some more.
Investing solely on the basis of recent short-term past performance doesn’t work. In fact, it can actually magnify subsequent losses if the investment has already been gaining steadily for 12 months or more. Such investments very often wind up in the media spotlight, attracting a lot attention. By then, however, the smart money has already left, and the investment (a high-flying company or a hot commodity) is ripe for a steep slide.
Remember this phrase: “Past performance does not guarantee future results.” It’s a now common (and widely ignored) warning on every bit of marketing material produced by every mutual fund and ETF sold in Canada. And for good reason. When looking only at investment return graphs (another common mistake, by the way), make sure you look not just at the past month or six months or year. Go back three, five, ten years, or even longer if you can. Compare the return on the “hot” investment that’s caught your eye to a suitable benchmark over the longer term. You’ll often find that past performance doesn’t even guarantee good past performance let alone future results.
Mistake #3: Following the herd
Investors often stampede into or out of individual investments, sectors, asset classes, and entire markets at the same time. New clients have told me they’ve missed out on big market moves after selling all their equity positions and switching to cash after a stock market correction. The media-driven stock market “crashes” following Brexit and the election of Donald Trump as U.S. president are two cases in point in 2016. Investors jumped on the sell bandwagon simply because “the market was declining rapidly.” But these were one-day wonders, and markets rallied again in the wake of both events, whipsawing many investors into loss positions. In fact, “the market” is nothing more than the combined actions of millions of individual investors. If you sell only because the market is declining, you’re just following a herd mentality.
The best way to avoid these most common errors is to define your financial objectives and develop a disciplined portfolio allocation plan that takes into account your tolerance for risk. Work with your financial advisor to create a properly diversified portfolio that mitigates risk to a level acceptable to you. (Be realistic about the size of portfolio loss you’re comfortable with over various time periods.) Then stick with your plan.
© 2017 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.