Five Most Common Investment Mistakes

15 March 2016  |  Dr. Ella Rabener
Five Most Common Investment Mistakes
When investing, success does not only come from taking all the right steps but also from bypassing all the wrong ones too.
This is easier said than done but circumventing these blunders can go a long way in helping you create the financial future you’ve always dreamt of.

When investing, success does not only come from taking all the right steps but also from bypassing all the wrong ones too. This is easier said than done but circumventing these blunders can go a long way in helping you create the financial future you’ve always dreamt of.

Nothing ventured, nothing gained. The profound wisdom of this four-word phrase rings a bell whenever we delve into the unknown and unfamiliar. But as part of that process, mistakes are bound to happen. Mistakes are how we learn. But when your mistakes end up losing you money, they must be avoided at all costs.

Investing is one such territory that is essential for your financial future but also very daunting and baffling for those who don’t know what they’re doing. The very word can conjure up some unsettling emotions. But planning for retirement or your children’s education isn’t something that should be delayed.

An unwavering focus on your long-term objectives and learning from others’ mistakes can significantly boost your chances of making your money work hard for you. You can’t guarantee returns but you can significantly improve returns by becoming aware of these pitfalls and taking steps to circumvent some of the most common blunders that afflict investors.

Even a broken clock is right twice a day. Just because someone successfully times the market once, it doesn’t mean it is a sure way to make money

Here are five mistakes that investors have a tendency to commit, especially in periods of increased market volatility and instability.

1. Failing to diversify enough

The best way to avoid suffering severe investment losses is to ensure your portfolio is sufficiently diversified. To do so, you should ensure that you are ready for whatever the market might throw at you by investing appropriately across different asset classes including: equities, bonds, commodities, real estate and cash. Your holdings should reflect your investment time horizon, the returns you are hoping for and the risk you are willing to take.

The principle of a diversified portfolio is based upon the Nobel Prize winning ideas of Markowitz who concluded that because different assets respond differently to market conditions, it is possible to design a portfolio in which you would be less exposed to market downturns.

2. Trying to time the market

“Even a broken clock is right twice a day”. Just because someone successfully times the market once, it doesn’t mean it is a sure way to make money.

Market timing is nearly impossible, and predicting peaks and troughs is a fool’s game, but that doesn’t stop a large numbers of people from trying. This means that purchases at the top of the market and sales after the bad news is already out are all too common and both are simple ways to dramatically reduce your returns.

People try to time the market by reacting to news in the press, for example selling Volkswagen stock because they hear about the emissions issues in the US, buying Apple stock because they hear the new iPhone is doing great, selling because they hear China’s growth is slowing.

But when a story is reported in the news, it is typically reflected in the share price almost instantaneously and is already old news. This means the chance to react to the market has already been missed, and you will simply be part of a large crowd bailing out too late and in this respect will lead many to buy high and sell low.

3. Paying High Fees for Investment Managers

Small Differences in Annual Fees have a Large Impact on Performance Over Time

Scalable Capital vs Traditional Investment Manager
Past performance or future projections are not indicative of future performance.

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.

The fact that 85 percent of fund managers fail to outperform the stock market after costs each year only corroborates this claim.1

Look for funds that have fees that make sense and make sure you are receiving value for the advisory fees you are paying because many times, they don’t generate enough of a return to make up for their high fees and often underperform when compared with the market.

The chart illustrates the performance of an investment of £100,000 over a 30 year time horizon and different fee levels assuming the same annual return of 6%.2

4. Focusing on absolute rather than risk adjusted returns

People try to decide what fund to invest in by looking at the historical performances in the form of the absolute annual returns a fund has generated. It is only natural to be impressed by a strong track record. But what most of them forget is that historical performance doesn’t allow you to predict future returns.

Also, absolute annual returns don’t mean anything unless you put them into perspective with the underlying risk of the applied strategy, for example by looking at a Sharpe ratio . Would you rather invest in a fund that was down 10% and then bounced back up 5% or another fund that never went into the red but in the end returned 4%?

5. Meddling with your account too often

The idea that doing something is better than nothing is ingrained in most of us that care and think long-term enough to invest. But tinkering with your portfolio too often is not the best way to ensure your investment grows. Meddling with your account too often can often lead to losing a lot of money in transaction fees and you may end up incurring more losses due to increased trading activity.

Also, if you keep transferring investments in response to downturns in prices, you might miss the upturns too.

1 https://www.institutional.vanguard.co.uk/documents/case-for-index-fund-investing-uk.pdf
2 Scalable Capital Cost: 1% p.a. (0.75% p.a. All-in fee + 0.25% p.a. ETF average cost). Total Expense Ratio for a selection of major UK wealth managers: Average charge paid to the wealth manager: 1.37% p.a., Average cost of managed funds invested into: 0.58% p.a., Average cost of ETFs/ITs invested into: 0.39% p.a.. Assuming 50:50 split between ETFs and managed Funds – average fund charge: 0.48% p.a.. Total Expense Ratio: 1.85% p.a. Source: Numis Securities pricing model Feb-2015, own calculation for averages.

Risk Warning – With investment comes risk. The value of your investment can go down as well as up and you may get back less than you invest. Past performance or future projections are not indicative of future performance. We do not provide any investment, legal and/or tax advice. If this website contains information regarding capital markets, financial instruments and/or other topics relevant for investments of assets, the exclusive purpose of this information is to give general guidance on investment management services provided by members of our group. Please note our Risk Warning and the Website Terms.

 

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Dr. Ella Rabener
CMO & UK CO-FOUNDER
Ella combines finance expertise, completing a doctoral degree in business and advising leading financial institutions while working with McKinsey & Company, with several years of experience building e-commerce startups, most recently as founder and CEO of Westwing.ru.