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Five common investment mistakes

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24/07/2014
While we may all consider ourselves rational creatures, who make decisions carefully and with due consideration of all the important points, we are all human and therefore vulnerable to making mistakes.

Certainly aspects of basic human behaviour are in conflict with being a successful investor. Here are some of the most common mistakes:

1) Following the herd
Stock markets are simply a collection of buyers and sellers. If there are lots of buyers for a company’s shares, the price goes up; if there are lots of people selling, the price goes down. Given that the most important part of successful investment is to buy at the bottom and sell at the top, buying when everyone else is buying makes no sense. And yet that’s what lots of people do, reassured by the ‘wisdom of crowds’. It is a quick way for a novice investor to lose lots of money. The most obvious example of this was the technology bubble of 1999/2000, when lots of investors found to their cost that investing with the herd was a quick way to lose a lot of money.

2) Buying complex investments
People involved in financial markets love jargon, much of which will mean nothing to the average investor, but can bamboozle them into believing they are buying something really good. The new currency-hedged futures and options strategy really sounds like the path to riches. But if you don’t understand it, or are new to investing, you really are better off investing in something a little simpler. Warren Buffet has become a very wealthy man investing in straightforward companies that make things such as chocolate or fizzy drinks. Investors can only make a valid judgement on whether an investment is right for them if they understand what’s going on underneath the bonnet.

3) Trusting the wrong people
There are some people worth listening to about stock market investments: those that live in big houses bought from the proceeds of their stock market investments might be one group, qualified financial advisers might be another. In general, it is best not to listen to your builder/plumber/friends in the pub unless they happen to fall into one of the previous two categories. It is worth considering that fund managers spend every day analysing stocks, often with team of economists and financial analysts on hand to help, and even they get it wrong sometimes. Are you sure that your builder/plumber/friends in the pub necessarily have greater insight?

4) Hanging onto losing stocks and selling your winners
No-one likes to admit they have made a mistake and they quite like the warm and fuzzy feeling of being right. As a result, people are prone to taking profits on their good investments as soon as possible, and hanging onto your ‘losing’ investments in the hope that they will eventually turn around. They probably won’t. A 10-20% loss should prompt you to re-evaluate why you are holding a particular investment and test whether it should still be in your portfolio.

5) Not paying attention to risk
Regardless of your situation, the temptation is often to go for the highest growth investment possible – after all surely the whole point it to make as much money as possible: From technology to commodities to frontier markets, investors often simply ask which is going to make them huge amounts of cash so they can move to the Bahamas and retire. Life-changing returns are hard to come by and most investors are better off investing according to some realistic long-term financial goals, such as university fees for your children, retiring a few years earlier, or a long holiday. This is likely to be a much better way of growing your capital over time. Ultimately, the effect of compounding returns is likely to be a far more potent contributor to your long-term wealth than picking the in-vogue investment of the day.

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