If, like me, you are a keen golfer, you will understand that the top players at your club aren’t necessarily those who hit the highest number of great shots. They are simply the ones who are most consistent and hit the least number of bad shots over the course of a round.
In the same way, when it comes to investing, achieving superior long-term investment returns isn’t actually about making the big calls on timing the market and stock selection.
As exciting as both of those ideas can appear to be (and they certainly have been used the basis for many a tale that has been woven by the storytellers of the world’s asset management firms for years), actually getting them right plays an insignificant role in long-term investment success.
I was recently fortunate enough to get hold of a copy of Behavioural Investment Counselling by Nick Murray. It’s considered to be one of the seminal works about investing, and I’d been looking for a copy for ages, until I was able to buy a second-hand copy!
The book has been a profound read for me, because it is helping me now articulate a lot of the observations that I have noted, both in relation to both the successful and less successful investors I have met over the 20 years I have been advising clients. In his book, Murray reiterates the point I’ve made above regarding long-term investment success. He also sets out eight common mistakes investors make, and why avoiding them is very much the key to growing your wealth.
As financial professionals, we always preach that a well-diversified portfolio is a desirable thing and one of the essential components of an effective investment strategy.
However, it’s easy to go too far in this regard and allow a lack of investment discipline to distort your portfolio.
In my experience, this often occurs when you’re guided by lists of top-performing funds or stocks and see adding them to your portfolio as a shortcut to financial success.
Like a child in a sweet shop, it’s tempting to want to try a bit of everything. But continually buying stocks with no regard to your overall investment strategy can mean you end up with an incoherent muddle of different holdings with different assets, geographies, sectors, or themes.
This results in a portfolio that isn’t cohesive enough to meet your objectives, and you become more of a collector rather than an investor.
2. A lack of diversification
From one extreme – too many funds – to the other, which is not enough diversification in your portfolio.
At the very worst, this can result in your entire holdings consisting of just one stock. For example, I’ve met many a corporate employee hanging on to their accumulated stock options, waiting until it hits a certain value. This is a figment of their imagination and, from a legal perspective, outside of their control.
It can also involve an over-reliance on a single market sector. Often, this emanates from “home bias”, which is a preference for investing in your home market. Alternatively, you may have too much focus on a specific theme such as technology stocks or utilities.
3. Being susceptible to market euphoria
Often mislabelled as “greed”, market euphoria describes the phenomenon where investors collectively start behaving irrationally and demonstrate an inexplicable loss of financial judgement.
It can also be described as the “fear of missing out”, or “Fomo”. The history of investing is littered with various “bubbles” as a result of this, ranging from an obsession with Dutch tulip bulbs in the 17th century to the dot-com boom in 2000.
In each case, speculators got carried away chasing a particular fund or market and assumed that it would defy the laws of investment gravity by continually rising.
While investing money is about the great businesses you may be investing in, it’s also about psychology. As Warren Buffett once advised investors: “Be fearful when others are greedy, and greedy when others are fearful.”
4. Panicking at any sign of bad investment news
From an investment perspective, the reverse of euphoria is panic. Often one will follow the other.
If you can remain level-headed about your investment strategy – almost to the point of disinterest – then you are very likely to end up better off than if you’re overreacting to every market movement.
An old mentor of mine used to say that the growth in your portfolio is often in inverse proportion to the number of times you check the value.
I can vouch this is absolutely true having observed this many times, not least with respect to the impressive returns on an investment portfolio of my own mother’s. I remember she asked me to take a look at this particular investment in 2009 and the returns were impressive, even though it was at the worst point of the financial crisis bear market.
You should remember that investing is a long-term undertaking, so succumbing to panic at losses, while a totally human reaction, can result in misjudgement and potentially catastrophic financial decisions.
5. Borrowing money to invest
I’ve often seen private banks “recommending” loans for investment purposes. Their offer will reference an ostensibly low interest rate in comparison with the high rates of return you can expect on your investments.
However, it’s a strategy that is fraught with danger, and can often end with only the private bank making a profit. Of course, it’s good business for them, as not only do they charge asset management fees your existing investment portfolio that is used as security for the loan, but they will also charge interest on the loan itself. Furthermore, they will charge yet more asset management fees on the loan proceeds which get invested.
With a loan hanging over you, you may be driven to make poor decisions as any investment losses will become amplified both in reality and in your mind as it could become a serious problem.
Aside from that, any margin calls – when the bank says the collateral is insufficient because the value has dropped and you have to sell down some of the investments at a loss in order to reduce the loan – will force you to be selling just at the point that the only right course of action is not to sell.
6. Speculating rather than investing
This mistake can come from an amalgamation of three of those you’ve already read about: panic, euphoria, and over-diversification.
It can derive from following hunches, or reacting to investment tips you may get from work colleagues or – the more likely culprits – the financial press.
You may also be prompted by the latest investment theme in glossy market updates from asset managers. In most cases, by the time you read about a specific investment opportunity, the chance to turn a quick profit will have already gone.
If you are looking to buy and sell stocks in the short term, then you are no longer an investor. In reality, this kind of investment is speculation and should play no part in any long-term investment strategy. Especially a strategy that is fundamental to the realisation of your family’s future financial security.
If you like the buzz of day trading and investment speculation, it’s far better to ringfence an amount of “play” money for this. But you’ll need to be strict with yourself and avoid meddling with your long-term portfolio that’s there to secure your long-term goals.
7. Focusing on current yield instead of total return
The power of dividends is well known and reinvesting them will contribute to a significant part of your total returns.
For example, a Saltus report revealed some Barclays modelling showing that a £100 investment into UK shares as far back as 1899 would have been worth £15,179 in 2019 (unadjusted for inflation) without any dividend reinvestment.
But if you had reinvested your dividends, then – ignoring tax on the dividends – your £100 investment would have had a nominal value of nearly £2.9 million. That’s quite a difference!
The problem with dividends comes if you base your income strategy on those paid out from high yield stocks.
For one thing, you may well end up reducing your diversification, as outlined in point two, as stocks in certain sectors are known to typically have higher yields. You may also be investing in companies that are prioritising their dividend yield ahead of investing in the business.
8. Letting your cost basis affect your investment decisions
As part of your investment strategy, it’s important to avoid making investment decisions purely on the basis of how much a certain stock or fund originally cost you to purchase.
Holding on to a stock until it has reached a pre-determined value or will provide you with a specific amount of profit can distort your portfolio and leave you making poor decisions that can actually accentuate losses rather than help you avoid them.
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If you need help developing an investment strategy that aligns with your financial goals, we are here to help.
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This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.