As an investor initially, it is common to be jittery and anxious about your investments. So, we prepared a list of common pitfalls to avoid as you begin your investing journey.
Timing the market
“Buy low and sell high” is the mantra for a successful investor. However, legendary investor Warren Buffett admits, “People that think they can predict the short-term movement of the stock market — or listen to other people who talk about (timing the market) — they are making a big mistake.” His advice is “You’d be making a terrible mistake if you stay out of a game you think is going to be very good over time because you think you can pick a better time to enter.”
As a beginner, you would do well to invest your money regularly. By investing regularly, your money would buy fewer shares when markets are peaking and buy more when markets are bottoming out. Such a strategy would help you achieve a lower average price per share over the long term than if you were to try and time the market.
Chasing the herd
Would you buy a stock recommended by friends (assuming they are not professional investors) or those that even your hairdresser seems to be buying these days? If your answer is no, well done! You are free of the herd disease.
If you had followed the herd and invested all your money in internet stocks in the late 1990s by April 2000, you would have seen your portfolio decline by 25% in a single week! After the bubble in Japanese stock market and real estate burst the Nikkei Stock Index plunged by 50% between 1990 and 2000.
The latest demonstration of herd mentality and irrationality in financial markets has been in cryptocurrencies such as bitcoins which been called the “mother of all bubbles” by renowned economist, Nouriel Roubini.
Bubbles are here to stay, and you will do your investment portfolio a favour by doing thorough research before investing instead of following the herd.
Investing all your eggs in one basket
A well-diversified portfolio is essential for long-term gains with minimum volatility in your investment portfolio, especially for retail investors. This means that you invest your money across different asset classes such as stocks and bonds, across different sectors and even across different geographies. Diversification helps reduce volatility and reduces overall portfolio risk.
The question arises what percentage of your total portfolio you should invest in different asset classes? This question is especially important as studies have shown that asset allocation is a key driver of investment results. A common investment strategy is to invest 60% of your money in equities and the rest in bonds. According to Vanguard, such a portfolio would have an average annual return of 8.7% in dollar terms from 1926-2016.
For more sophisticated asset allocation strategies one can consider Markowitz’s Modern Portfolio Theory, Risk-based asset allocation framework and use the Value-At-Risk framework. Sounds too geeky? It’s best left to professionals and institutions to build and implement the more sophisticated asset allocation strategies for you.
Letting your emotions sway your investment decisions is a sure way to lose a lot of money while investing. Your emotions are your worst enemy when it comes to investing.
After the Brexit vote results were announced, the FTSE 100 fell more than 8% within the first few minutes of trading. If one had panicked during the massive selloff and sold all their investments in the FTSE 100 that time, he would have missed out on the subsequent recovery by over 15% of the FTSE 100 since Brexit.
Volatility (defined as “rate at which the price of a security increases or decreases for a given set of returns”) is inevitable in financial markets and some days are more volatile than the others. When there is a bloodbath in the financial markets, just take a deep breath and sit tight. If you have a well-diversified portfolio and you invest regularly, you will do just fine in the long run.
Ignoring high fees that don’t justify the fund’s performance
An effective way to destroy your portfolio returns is by investing in funds that have high fees and yet underperform the market. According to a study by the UK financial regulator, 99 percent of actively managed US equity funds sold in Europe have failed to beat the S&P 500 over the past ten years. Almost 97 percent of emerging market funds have also underperformed after accounting for fees.
If you invest £100,000 over 20 years, a 1% annual fee will reduce your portfolio value by nearly £30,000 compared to a portfolio with 0.25% annual fee (Source: SEC’s Office of Investor Education and Advocacy). Here is an investment fees calculator that will you can use to find out the effect of fees on a portfolio over 30 years.
Often fee structures in funds are not transparent. Consider the total fees while investing in a fund which could include expense fees, trading costs, withdrawal fees and performance fees. Some funds also charge performance fees against a very low target. Read the Key Investor Information Document (KIID) thoroughly to understand the total fees that the fund may charge you before investing.
To sum up always remember about the 3 R’s that are key to success in investing: Research, Rationale, and Restraint.