Some Common Mistakes made by Investors
There has been a lot of discussion in the media recently on the lack of retirement savings of many working Australians. Whether its your superannuation or other investments, mistakes along the way can lead to significant reductions in the returns your receive from your investments. This article looks at some common mistakes that can have an impact of your long term investment returns.
No Written Plan
It is interesting that people will spend days planning a two-week holiday but then make investment decisions worth tens of thousands of dollars seemingly on a whim.
The act of writing a plan doesn’t put money in your pocket. But people who are methodical enough to put their plans in writing are also likely to do many of the other things that lead to successful investing. Of course, even the most brilliant plan is worthless if it just collects dust on a shelf.
With a plan, you can get back on course when you go astray. Without a plan, you may not know that you are off course.
If you don’t have an investment plan that’s right for you, developing one should be your top priority.
Procrastination
Waiting for the right time can ruin your results over a lifetime. Procrastination takes many forms. You don’t start saving for retirement until it’s nearly on top of you. You “know” you should review your investments but other things always seem more pressing. You think you’ll catch up later when the market is better, when you’re making more money,or when you have more time.
And there’s the irony, because the longer you wait, the less time you have. Every day you delay is a day of opportunity that you can never get back.
Taking too much Risk
Investing requires taking some risk, but many people take too much. They probably know that higher returns go hand in hand with higher risks. However, they may believe they are immune from losses or that they’ll somehow know when it’s time to sell. The problem is that by that time, it’s usually too late. Their desire for high returns simply puts the blinkers on.
Taking too Little Risk
Some people are paranoid about the thought of losing any money at all. They want everything nailed down, secure, guaranteed. The sad truth is that absolute security is only an illusion. It doesn’t exist anywhere in nature and it certainly doesn’t exist in financial markets.
Very low risk almost always equates with low return. If you put your emergency money in a bank account and earn 1 percent, you may think you’re taking no risk. But in fact you are taking the very real risk that inflation will rob your money of its purchasing power. Over long periods this stops being a risk and becomes almost a guarantee.
If you put your life savings in very low-risk investments, you are giving up an enormous opportunity.
Believing publications
“The 100 Best Investment Funds”
“Hot Shares for 2006.”
You will be familiar with these newspaper and magazine headlines.
Serious investors need textbooks more than hot ideas. But people don’t want textbooks. They want entertainment, and that’s what publications and broadcast outlets provide.
The right way to read financial articles that tout specific funds and shares is to treat them as useful sources of interesting ideas. But it's a mistake to regard those articles as prescriptions of what you should do with your money.
Writers, editors and publications follow fads. They write about what’s in favor and in style. When the winds of popularity change, they are never far behind. That’s a very poor basis for making investment decisions.
Failing to take little steps that can sometimes make a big difference
One small example ;
People don’t move their money from a cheque account to an interest earning account at a bank.
There are a number of little steps like the above that will make a difference. And over a lifetime the little differences add up to big differences – but only for people who take advantage of the opportunities presented.
Investing in financial products that have little liquidity
Liquidity is the ability to get your money back quickly, to turn an investment into cash. Investments in shares are very liquid, because you can sell them whenever the market is open, and you’ll have your money in a few days.
Investment directly in property is less liquid than shares because it takes time to find a buyer and more time for the sale proceeds to come through.
Other investments are relatively ill-liquid, for example, partnerships in agricultural schemes. It often happens in these circumstances that there is no market. When partners in such a scheme want to sell, they often find that everybody else wants out, too, and there are few buyers at any price.
Not only do you lose money but you also lose the opportunity of reinvesting your funds in areas offering better returns.
Accepting investment advice and referrals from amateurs
If you had a serious illness, you would consult a nurse or a doctor, not somebody on the street who had an opinion about what you should do. And I hope you would treat your life savings and your financial future with the same care as you would treat your health.
Yet too many people make big financial decisions based on things they hear. “I heard this hot tip.” “I know somebody in this company.” “I’ve got an inside source about this new product.”
The lure of the hot tip is all but irresistable to some investors eager to find a shortcut to wealth. Unfortunately, many investors have to learn the hard way that there are no reliable shortcuts.
Letting emotions – especially greed and fear – drive investment decisions.
I think the two most powerful forces driving markets are greed and fear.
There’s fear of rising interest rates, fear of inflation, fear of falling profits. You name it, somebody’s afraid of it. Fear is why so many investors bail out of carefully planned investments when things look bleak – and since everybody seems to be selling at the same moment, prices are down. That, in turn, reduces profits or increases losses.
Greed blinds investors, making them forget what they know. In late 1999 and early 2000, greed prompted many inexperienced investors – and some experienced ones too – to stuff their portfolios with high-flying technology shares, which had just had a terrific year. Then in late 2000, technology shares, especially the most aggressive ones, plunged without warning, leaving many of these greedy investors wondering what had hit them.
Investors obviously want to make money. But this legitimate desire turns into greed when it runs amok. Likewise, investors obviously should want to avoid losing their money, yet when a healthy respect for bear markets leads to panic selling, caution becomes counterproductive.
Putting too much faith in recent performance
Most people tend to think that whatever just happened will continue happening. Sometimes that’s true, but a great deal of the movement in the share market is random. Recent performance is a lousy predictor of long-term performance.
Ironically, recent performance is at the heart of the active risk management systems that are used and advocated. These systems don’t predict the markets; instead, they identify and follow existing trends, on the presumption that those trends are likely to persist long enough to take advantage of them.
Failing to resolve disagreements between spouses
It’s not uncommon for members of a couple to have quite different comfort levels and priorities for investing money. He may think she’s taking excessive risks; she may think he’s hopelessly conservative. Or of course it could be the other way around. When couples discuss finances, including investments, there are often power struggles going on under the surface. And when somebody is determined to “win” or to “keep the peace,” sound investment decisions often suffer.
Focusing on the wrong things
It’s generally agreed that asset allocation – the choice of which assets you invest in – accounts for at least 95 percent of investment returns. That leaves less than 5 percent for choosing the best shares and the best investment funds. Most investors focus at least 95 percent of their attention on choosing funds and shares, where their energy would usually be better spent on asset allocation.
Lack of Diversification
Many people don’t understand diversification; they just know that it’s supposed to be good for you. They would be better investors if they learned how to put together non-correlated assets.
The list of mistakes above is in no way exhaustive. It does demonstrate that there are many things to consider when developing your investment strategy which includes your superannuation.
If you have any further questions on the above issues, please call this office.