Common mistakes investors make
This week is World Investor Week, which aims to promote financial literacy around the world. The global inititaive, spearheaded by the International Organisation of Securities Commissions and the World Federation of Exchanges, is led in Bermuda by the Bermuda Stock Exchange. In keeping with the week, this is an article by Robert Stammers of the CFA Institute, looking at the most common mistakes made by investors. Part two, featuring ten more common mistakes will appear in tomorrow’s edition.
1. Expecting too much or using someone else’s expectations Investing for the long term involves creating a well-diversified portfolio designed to provide you with the appropriate levels of risk and return under a variety of market scenarios. But even after designing the right portfolio, no one can predict or control what returns the market will actually provide. It is important not to expect too much and to be careful when figuring out what to expect. Nobody can tell you what a reasonable rate of return is without having an understanding of you, your goals, and your current asset allocation.
2. Not having clear investment goals
The adage, “If you don’t know where you are going, you will probably end up somewhere else,” is as true of investing as anything else. Everything from the investment plan to the strategies used, the portfolio design, and even the individual securities can be configured with your life objectives in mind. Too many investors focus on the latest investment fad or on maximising short-term investment return instead of designing an investment portfolio that has a high probability of achieving their long-term investment objectives.
3. Failing to diversify enough
The only way to create a portfolio that has the potential to provide appropriate levels of risk and return in various market scenarios is adequate diversification. Often investors think they can maximise returns by taking a large investment exposure in one security or sector. But when the market moves against such a concentrated position, it can be disastrous. Too much diversification and too many exposures can also affect performance. The best course of action is to find a balance. Seek the advice of a professional adviser.
4. Focusing on the wrong kind of performance
There are two timeframes that are important to keep in mind: the short term and everything else. If you are a long-term investor, speculating on performance in the short term can be a recipe for disaster because it can make you second guess your strategy and motivate short-term portfolio modifications. But looking past near-term chatter to the factors that drive long-term performance is a worthy undertaking. If you find yourself looking short term, refocus.
5. Buying high and selling low
The fundamental principle of investing is to buy low and sell high, so why do so many investors do the opposite? Instead of rational decision making, many investment decisions are motivated by fear or greed. In many cases, investors buy high in an attempt to maximise short-term returns instead of trying to achieve long-term investment goals. A focus on near-term returns leads to investing in the latest investment craze or fad or investing in the assets or investment strategies that were effective in the near past. Either way, once an investment has become popular and gained the public’s attention, it becomes more difficult to have an edge in determining its value.
6. Trading too much and too often
When investing, patience is a virtue. Often it takes time to gain the ultimate benefits of an investment and asset-allocation strategy. Continued modification of investment tactics and portfolio composition can not only reduce returns through greater transaction fees, it can also result in taking unanticipated and uncompensated risks. You should always be sure you are on track. Use the impulse to reconfigure your investment portfolio as a prompt to learn more about the assets you hold instead of as a push to trade.
7. Paying too much in fees and commissions
Investing in a high-cost fund or paying too much in advisory fees is a common mistake because even a small increase in fees can have a significant effect on wealth over the long term. Before opening an account, be aware of the potential cost of every investment decision. Look for funds that have fees that make sense and make sure you are receiving value for the advisory fees you are paying.
8. Focusing too much on taxes
Although making investment decisions on the basis of potential tax consequences is a bit like the tail wagging the dog, it is still a common investor mistake. You should be smart about taxes — tax loss harvesting can improve your returns significantly — but it is important that the impetus to buy or sell a security is driven by its merits, not its tax consequences.
9. Not reviewing investments regularly
If you are invested in a diversified portfolio, there is an excellent chance that some things will go up while others go down. At the end of a quarter or a year, the portfolio you built with careful planning will start to look quite different. Don’t get too far off track! Check in regularly (at a minimum once a year) to make sure that your investments still make sense for your situation and (importantly) that your portfolio doesn’t need rebalancing.
10. Taking too much, too little, or the wrong risk
Investing involves taking some level of risk in exchange for potential reward. Taking too much risk can lead to large variations in investment performance that may be outside your comfort zone. Taking too little risk can result in returns too low to achieve your financial goals. Make sure that you know your financial and emotional ability to take risks and recognize the investment risks you are taking.
• Robert Stammers is the director of investor education for the CFA Institute. For more information, please consult http://www.cfainstitute.org/investor/
The information contained in this piece is not intended to and does not provide legal, tax, or investment advice. It is provided for informational and educational use only. Please consult a qualified professional for consideration of your specific situation
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