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Even the very best, most experienced investors make mistakes. The great Warren Buffett, for instance, claims that he regrets some of the decisions he made over the years. A case in point was his purchase of Berkshire Hathaway stocks in the 1960s, a self-described “vindictive mistake” which he estimates cost him $200bn.
It’s important to recognise that if you invest in the markets for any length of time, you’re likely to make some mistakes. The point is to try to identify the ones that can be prevented, especially those which require the extra, impartial eyes of an experienced financial planner. In this short guide, our financial planning team here at WMM will be sharing six common investor mistakes, and what you can do about them:
#1 Investing in something you don’t understand
It’s unlikely that any of us can ever fully understand every investment in our portfolio. Each fund comprises multiple companies, for instance, each of which has multiple dimensions to it; profiles of business owners, cash flow forecasting, profit and loss, operational differences, distinct customer bases and different stages of product development/maturity. Understandably, few ordinary investors have the time to get their heads around all of this.
With that said, it’s important to have at least a basic understanding of your investments. Which sectors do the companies within your funds operate in, for instance, and how do they make their money? Do you know the primary differences between investing in bonds and equities? Perhaps your current financial adviser has recommended you invest in something, and you feel uneasy as you don’t quite understand what it is they’re suggesting?
#2 Allowing emotions to rule
If you look at your investment portfolio and notice one of your ‘Index’ funds starting to plummet, how do you react? Typically, many people start to panic and some even try to pull their money out before they “lose any more”. This kind of reactive investment approach is one of the worst things you can do, however.
Quite often, pulling money out during these moments can cause more harm than simply staying in the market to ride out the storm. If you feel yourself getting nervous during this kind of market volatility, take a deep breath and take a step back. Have these sorts of movement happened before? Did the markets eventually climb back up again? Quite often, the answer is yes.
#3 Trying to time the market
On the other side of the coin, another common investment mistake we often see is “pre-empting the market.” Here, you might pull money out of a stock before you think it’s about to fall in price. Or, you might commit capital towards a stock which you anticipate will imminently rise. This is essentially what professional active fund managers do on behalf of their clients. Unfortunately, it is notoriously difficult to do consistently well. Even experienced fund managers typically fail to time the market effectively over the course of many years. Again, stay in the market. Don’t try to time it.
#4 Not diversifying sufficiently
Earlier in 2019, many investors were unfortunately hit by the decline and eventual closure of Neil Woodford’s flagship UK Equity Fund. At its peak, it was valued at £10bn, and eventually fell to about £2.9bn before investors’ money was locked due to the fund’s suspension. Those who put most or all of their eggs into this basket would have felt the financial pain very acutely. Those who had their capital spread out across multiple asset classes and funds, however, would have been shielded from significant damage. It’s a reminder that diversification is key to a long term, successful investment strategy. Putting your faith into one “hot stock” or fund is a big risk.
#5 Relying on past performance
It’s important to consider how successfully different funds and investment opportunities have delivered strong returns for their investors in the past. However, it’s a common mistake to assume that good past results will determine what happens in the future. Other factors are also important to consider with your financial planner, such as a fund’s fundamentals. Again, the Neil Woodford fund is a good example. Despite outperforming the FTSE All Share throughout the early 2000s, his UK Equity Fund is now closed. One important reason widely acknowledged for this was the fund’s high reliance on unlisted assets.
#6 Forgetting fees and inflation
There are numerous forces which can erode your investment returns if you are not careful. Inflation, for instance, erodes the real value of the money in your investments. This is one reason why regular savings accounts in 2019 tend to offer such poor value for those looking to grow their wealth. After all, if you have a 1% return from interest but are facing a 2% inflation rate, you are actually losing money. A lot of investors fail to take inflation into account when analysing the preservation and growth of their wealth. Be careful not to neglect this yourself.
Investment management fees are another area where investors can sometimes fail to notice the erosion of their returns. Actively-managed funds can be particularly expensive since they need to employ an active fund manager who regularly buys and sells investments (transactions which, themselves, are often taxed and these costs are passed on to the investor). Again, speak to your financial planner to ensure that you are not paying more than is absolutely necessary when it comes to managing your investments.
If you are interested in starting a conversation about your portfolio, then we’d love to hear from you. Get in touch today to arrange a free, no-commitment consultation with a member of our friendly team here at WMM.
Reach us on 01869 331469