Six common investment mistakes to avoid
Becoming emotionally attached to investments
Becoming emotionally attached to investments – be they winners or losers – can end up being very costly indeed. In the words of Warren Buffett, the world’s most successful investor: “Success in investing doesn’t correlate with IQ … what you need is the temperament to control the urges that get other people into trouble in investing.”
Day-to-day market movements shouldn’t matter if you are focused on the long-term – it is rare that you will need to act immediately. When others are panicking, it pays to be patient and wait for the frenzy to calm down. Just consider how much money would have been lost in the market reaction to the UK’s vote to leave the European Union last year. There was a brief “panic” sell off but the FTSE 100 recovered in a matter of days. It pays to keep a clear head. Although ignoring emotion is easier said than done, it is essential to become a good investor.
Employing narrative fallacy
We humans are obsessed with creating narratives that do not exist. We seek to explain and understand the world, but by doing that we can introduce errors in our thoughts – errors than can lead us to make mistakes in the future. Narrative Fallacy is our inability to look at a sequence of facts without weaving an explanation into them. We form relationships between facts that have no relation at all because we believe explanations bind facts together.
A lot of this is seen in news reports, particularly reports about markets. For example: “The dollar fell today after economists at Charles Stanley said they expected interest rates would rise at a slower pace than expected”. This sentence implied that the dollar fell because of a view expressed by our esteemed economists. Try not to do it with your own thoughts.
Expecting to be right all the time
Investing is about being right more than 50% of the time. Hopefully much, much more. No-one, even the world’s so-called greatest investors, are right all the time – and self-directed investors should not punish themselves if they are not. You will not make money over all time periods. This is the equivalent of winning every single stage in the Tour de France. It simply will not happen, as investors are essentially trying to predict the future and this is an utterly impossible task.
As long as you learn from your investing mistakes it is fine. Being wrong comes with the territory so have a humble attitude to what you are doing. If you try too hard to be right about every single decision and tiny market move, you may find yourself making the most mistakes by trying to be too precise with their analysis.
Unwittingly doubling up on risk
A common mistake is having too much of a portfolio facing in one direction. For instance, investing in mining funds and Chinese equities may offer little diversification. Many companies in the mining sector are reliant on Chinese growth, so it may mean the two areas rise and fall virtually in tandem.
Similarly, watch out for funds that overlap in terms of style or holdings, or which have big stakes in shares you already hold. Investors need to diversify – this reduces the mix.
Dealing with losses
Selling too early is a mistake all investors make. Often it is done with the right reasons, for instance a successful position has become too large. However, “running your winners” is a strategy that has benefited many of the world’s most successful investors. A big faller is a different matter.
Usually this means you got something wrong, or something has changed making the investment less appealing or more risky. This requires a cold assessment of the facts. Similarly, bargain hunting among shares that have fallen heavily might seem tempting, but quite often bad news is followed by more bad news – only buy in if you are convinced you want to own it for the long-term.
Not having a review level behind a position
To have a diverse portfolio of shares you probably need at least 20 individual investments – so you will need a lot of time to monitor them if you are managing them yourself. It is important to make the space to do this. Funds need less monitoring as you are essentially paying a fund manager to do this monitoring though fees, but you should certainly check them at least every six months.
The best way to prevent losses escalating is having a level at which you will review the shares. On some platforms you can have a stop loss where the shares are sold when they breech a certain level, but for some very volatile investments an automatic sales could turn out to be a disadvantage. Instead, you may wish to set up alerts that will inform you when your investment has fallen to a certain level and then decide whether you want to sell or not.
Garry White is chief investment commentator at Charles Stanley