Don’t put your portfolio at risk!
As a financial advisor and professional planner, I’ve seen most every investment mistake novice investors are likely to make. And around this time of year, when I undertake client portfolio reviews, clients often seem overcome with the urge to repeat the same investment mistakes that their advisors have so valiantly struggled to overcome. Trouble is, these investing errors are true proven wealth destroyers. So here’s my terrible trio of investing mistakes and what you can do to avoid them through 2014.
1. Market timing
In the litany of investment error, this has to be near the top of the list, if not in the number one spot. Many investors, especially the do-it-yourself variety, have an unfounded confidence in their ability to buy and investment at precisely the right time and sell 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” almost inevitably leads to frequent trading, moving money in and out of the market based on “gut feel” or guesswork. The thinking goes something like this: “My stock has gone up X dollars, so it must be a good time to sell.” So you sell, and watch your stock almost immediately rise another Y dollars. If you then buy back in, you’ll have incurred trading costs on both the buy and sell side, and you’ll have missed out on that additional gain. Likewise, if you sell for no good reason other than because your stock has dropped X dollars, and your stock subsequently turns around in a rally, you’ll have done the worst possible thing: sold at the bottom. Overall, you’ll have incurred trading commissions and you’ll have missed out on subsequent gains.
If you pursue a market timing strategy, if it can be called that, when you invest in mutual funds or ETFs, you’re very likely to fare even worse, underperforming or even negating fund performance.
The fix. Good investing isn’t about timing. It’s about planning. Work with your adviser to develop an asset allocation strategy. That means first, you have to have 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.
2. Hoping for repeat performance
This very common mistake has been the undoing of many an investor. When I ask new clients why they had made a certain investment that now languishes in loss, they will frequently tell me that they “researched” it and saw that it had recently gone up in price. Some have even pulled out a price graph showing an impressive spike. A good recent example of this is gold, which until the final months of 2012 seemed on a trajectory of unending new highs. Until it ended, and the price of gold plunged through 2013, ending the year with a 28% loss.
Investing solely on the basis of short-term past performance of an asset 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 at the moment of their peak performance. They attract a lot of media and retail investor attention. By then, however, the smart money has already left, and the investment (a high-flying company, or a hot commodity like gold, for example) is ripe for a steep slide.
The fix. Remember this phrase: “Past performance does not guarantee future results.” It’s prominently displayed 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.
3. But everyone’s doing it!
This is also among the top three most common investment errors. It’s also a sure-fire wealth destroyer. And it’s often linked to mistake 1 and 2 above. Financial markets often act like a herd, as investors 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 (that’s a downside move of 10% from a recent high). They’ve done it simply because “the market was declining rapidly” and that got the Twitterverse into a frenzy. In fact, “the market” is nothing more than the combined actions of millions of individual investors. If you sell because the market is declining, you’re just following a herd mentality.
The fix: Same as for mistake 1 above. 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.)
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.