20 MOST COMMON INVESTING MISTAKES - PART 1
By avoiding some very basic mistakes that are often made, returns can be improved, and investment anxiety can be reduced.
The CFA Institute recently published an article that points out the 20 most common investment mistakes that investors should avoid. By avoiding some very basic mistakes that are often made, returns can be improved, and investment anxiety can be reduced.
The study was done using US data, but the same results apply irrespective of where you live. Let’s unpack these mistakes.
I will deal with the first 10 mistakes in this article and follow up with another article in a couple of days where the next 10 mistakes are dealt with.
Expecting too much
Having reasonable return expectations helps investors keep a long-term view without reacting emotionally.
The average investor expectation is 15.5% per year, while investment professionals expect returns of 7.0% per year.
Be mindful of what a reasonable return expectation is, and do not fall for unrealistic promises of so-called guaranteed returns. If it sounds too good … it probably is a scam.
No investment goals
Often, investors focus on short-term returns or the latest investment craze instead of their long-term investment goals.
59% of investors say that long-term growth is their top goal.
Different investment horizons justify different investment strategies. Make sure your investment terms and investment strategies are aligned.
Not diversifying
Diversifying prevents a single stock (or a single asset class) from drastically impacting the value of your portfolio.
21.4% of US stocks beat the market over 20 years from 1927 to 2020.
Diversification must be made on a global basis by using all asset classes. The world has evolved to be one large investment pool with tens of thousands of options. There is no excuse for a single-minded strategy.
Focusing on the short-term
It’s easy to focus on the short term, but this can make investors second-guess their original strategy and make careless decisions.
50%+ higher transaction fees were paid by investors with a short-term view.
Focusing on short-term returns increases investment anxiety, which leads to irrational behaviour. It does not make sense to adopt an equity-biased portfolio because tech stocks are rallying if you intend to use the invested funds within the next 24 months. You are bound to be disappointed …
Buying high and selling low
Investor behaviour during market swings often hinders overall performance.
2% = investors’ annual loss in returns due to buying high and selling low versus buy and hold strategies.
This trend is fueled by using recent performance to choose funds. The best-performing fund will more than likely drop down the ranks during the next year. Use fundamentals to decide on funds. As they say, past performance is no guarantee of future performance.
Trading too much
One study shows that investors with the highest trading activity saw poor performance.
6.5% = the average underperformance by the most active traders versus the US stock market.
This holds hands with point 5. Buying high will probably lead to selling quickly when returns disappoint. We often encounter erratic trading where investors manage their own portfolios. Often, they will re-invest in funds they sold in the last year or two because they have now again “started to perform”. Rather spend more time to try and understand why they underperformed and how the funds are positioned for anticipated interest rate and economic movements.
Paying too much in fees
Fees can meaningfully impact your overall investment performance, especially over the long run.
0.4% = the average fee for exchange-traded funds and mutual funds in 2022.
Bear in mind that the 0.4% is based on US funds. SA funds do tend to be a bit higher due to the difference in the size of the respective markets. There is also a meaningful difference in fees when comparing active versus passive funds. It does not necessarily mean that more expensive funds will automatically underperform cheaper funds. Many active managers, including some with performance fees, outperform the market and passive funds. It is, however, important to pay a fair, relevant fee based on the structure of the fund and the expertise of the fund manager. This is one time where past performance can be used to determine the track record of a particular fund manager. Remember that published returns are after the fund manager fees have already been deducted.
Focusing too much on taxes
While tax loss harvesting can boost returns, making a decision solely based on its tax consequences may not always be merited.
We find that when we want to disinvest or change funds for tactical reasons, some clients resist the change due to the capital gains tax (CGT) implications. They would rather remain invested in an underperforming fund than pay the CGT. There is a definite resistance to paying tax, and this can be costly as far as long-term returns are concerned. Don’t let then tail wag the dog.
Not reviewing regularly
Review your portfolio quarterly or annually to make sure you’re staying on track or if your portfolio is in need of rebalancing.
Long-term portfolio creep can distort a portfolio to be skewed as far as asset allocation and risk rating are concerned. This becomes particularly evident when a particular asset or sector severely outperforms, as we have witnessed in the tech space of late.
Misunderstanding risk
Too much risk can take you out of your comfort zone, but too little risk may result in lower returns that do not meet your financial goals. Recognise the right balance for your personal situation.
We often refer to the difference between risk and volatility. By definition, risk is the likelihood of incurring a permanent loss. In all honesty, there are very few high-growth funds that have historically incurred permanent losses over 10+ years. If we reduce the investment term, I can make the same statement and state that there are no low- and medium-equity funds that have incurred permanent losses over five+ years over any measure period and no money market funds that have incurred losses over one+ year.
On the flip side, the majority of pure equity funds failed to outperform cash over the last 12 months, with almost 20% returning less than 1% over the last year. The sector average for SA-based equity funds (which can include 45% offshore equities) is 3.9%, measured over 187 funds. Over five years, less than 2% of SA equity funds underperformed cash, there were no negative returns and the sector average measured across 159 funds was 8.95% per year. Disclaimer: the mentioned figures are current. Historically, there were periods when the five-year returns on equities were negative during extreme crises.
To illustrate the above comments, money market funds (that generally provide returns higher than cash in the bank) over the last five years returned on average 5.9% per year, while equity funds returned 8.95% per year. These are the average returns, not the best returns. We can expect money market funds to provide returns within a narrow margin from each other purely due to the limit options they have to invest in. Equity funds, on the other hand, vary vastly for example, over the past five years, returns varied between 15.5% per year and 2.4% per year.
Considering the above, it is not only important to match funds/investments with your investment horizon, but it is also equally important to structure a portfolio that has a high probability of providing returns closer to the upper limit of the sector rather than to the lower limit of the respective sector.
I will follow up with numbers 11 to 20 shortly. Hopefully, you find value in the information.
Invest wisely and take care.
