Novices especially prone to classic investment pitfalls
Markets go through periods of volatility, and we are in one such period now. Market sentiment has been decidedly sour for the past few weeks. The Dow Jones Industrial Average recently sank into correction territory. And crude oil prices have slumped, hitting the energy sector hard. Economic growth in China is coming in slower than expected rattling exporters and commodity producers. So what’s an investor to do? Do you sell your stocks, get out of the market, and put your money under a mattress? But that would be precisely the wrong thing to do. Investors can go a long way to calming down if they simply avoid these four classic investment mistakes.
Mistake #1: Obsessing about the business news
Novice investors fret way too much about the markets. Those without the benefit of a financial plan and professional portfolio management are especially prone to market fretfulness, especially as the 24/7 news cycle never shuts down! Many investors succumb to the daily panic-inducing headlines and tweets from the business news media. I’ve found that tuning out the daily business news “noise” goes a long way to restoring peace of mind. Remember, all that breathless reporting and those “crisis” headlines change by the minute – and there’s never a time of no crisis. It’s all designed to get as many “eyeballs” as possible to news websites and thus deliver a massive “visitor metric” to advertisers on those very same websites and social channels. Check the news if you must, but take it with a huge grain of salt.
It’s especially fruitless to obsess about minute-by-minute market and economic news if you have professional portfolio managers working for you. That’s what you’re paying them to do. And regardless of what your friends or colleagues may say, the pros are in fact much better at it than your barber or the neighbour with a “friend who’s a broker.” As the old saying goes, “There’s no point in buying a dog if you’re going to bark yourself.”
Mistake #2: 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, under-performing 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 re-balance in a year’s time.
Mistake #3: 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 #4: 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.