Wealth

Seven of the most common investment mistakes

In life, mistakes happen. The same is true in investing. With all of the historical data and experience we possess there is still no computer programme or individual that will get it right all of the time. This is because investing contains uncertainty. Moreover, investing is an emotional endeavour, especially when the money was the product of years and years of hard work and discipline. NMTBP examines some common mistakes investors make

1: Making Emotional Decisions

It’s true that investing is part science and part art. Because of this, generally speaking, successful investing should contain elements of each. Decisions made purely by emotion can bring disastrous results, just as decisions made only from a computer programme can also pose a problem. Emotional decisions are often tainted with biases. For example, when an investor buys a particular investment and it subsequently rises, they may adopt the belief that they were sure that would happen. Conversely, if the investment declines, they may convince themselves that they had a hunch that could happen as well. This inconsistency is because human behaviour has a tendency to arrange our thoughts to fit the thesis of the moment. This is where ‘behavioural finance’ enters the picture. Psychologists have identified a number of human biases which explain certain inconsistent patterns of behavior. The truth is, good investment decisions contain elements of number crunching as well as human reasoning. And, although it’s important to recognise this, it’s much easier said than done

2: Hold a loser in the hope it breaks even

The storyline goes something like this. You bought an investment and it lost value. Now it is down 20%. But when you bought it, you believed it was a good investment. Therefore, you’re pretty sure it will rebound and when it breaks even you’ll sell it. The truth is you’ll probably not follow through. Why? Because, if and when it comes back, you’ll hold it, believing it will continue to rise, reinforcing your initial belief that it was a good investment decision. Here’s the problem. If you were to sell it at a loss you’d be forced to admit that you made a bad decision. And admitting this is very difficult for some. In reality, sometimes it’s best to cut your losses and move on

3: Impatience

Investing requires a great deal of patience. Conversely, making rash decisions, in any endeavour, can be problematic. Most of us have been trained by modern day society to expect instant gratification. The truth is, life doesn’t work that way and neither does investing. Investing requires patience. For example, there are numerous instances where an investment severely lagged for several years before it turned around and became a top performer. This is not at all unusual. Therefore, assuming you’ve chosen a quality investment, to maximise its return you need to be prepared to hold it through a complete cycle to allow the manager’s strategy to play itself out. How long is a complete cycle? This can only be answered after the fact. It’s the same with indentifying the end of a recession. It’s normally several months after the fact before we realizs a recession has actually ended

4: Placing too much importance on past returns

When selecting an investment, don’t rely solely on past returns. For example, if you’re buying a fund it’s important to evaluate how the manager performed during a bad period in the markets, such as 2008. When you look at a fund’s performance during a bad year, if you find they lost markedly less than similar funds, it may be an indication that they have strong risk management controls in place. The importance of this cannot be overstated, especially when the next downturn occurs

5: Avoid rumour, gossip and ‘hot’ tips

Just because a friend recommends a particular investment it doesn’t necessarily mean it’s a good choice. Moreover, there are some important issues to consider. Here’s how a typical conversation unfolds. A friend tells you about this great fund they own (never mind the ones that didn’t work out). “In fact,” they say, “last year it returned X%!” “Wow,” you reply. “That’s more than I got!” Perhaps it really did do well. But here’s the relevant question. Will its performance be replicated? In other words, will the following year be as good as the previous year? The odds aren’t in your favour on that one. In fact, if you make your decision based solely on past returns, you stand a good chance of being disappointed. There are a number of important statistics to consider when investing, but past returns have very little to do with future returns. And, funds that were at the top of their peer group one year, often don’t remain there the following year

6: Failure to take profits

The saying “Nothing goes up forever and nothing goes down forever” is highly applicable to investments. With human nature as it is, most would tend to sell the losers and invest the proceeds in the winners. However, this would usually be the wrong decision. When you have a position which has risen and now has a substantial gain, it’s usually best to harvest some of its gains. Emotion tends to dictate that we keep the winners and sell the losers. But try to resist this urge

7: Investing near the top of the market

When investors suffer a major loss, as many did in 2008, fear spikes and they tend to sell their losers and wait on the sideline until they feel it’s safe to get back in. However, by the time they feel it’s safe to invest in the market again, it’s usually after the market has risen substantially. Even though we all recognise it’s best to invest when prices are low, because fear peaks after a major decline, most individuals are hesitant to reenter the market after a severe selloff. This is another mistake governed by emotion. To avoid this, it’s best to have rules in place that dictate when you will buy and when you will sell. In other words, to the extent you can remove emotion from the equation, your chances of investment success will rise, assuming your rules are sound of course

Summary

These are some of the more common errors investors make. To reduce your mistakes, be patient and even though it goes against how you may feel at a given moment, try to adopt a contrarian point of view.  Of course another way to remove some or all of the emotion from the equation is to hand over your portfolio to an experienced professional

You pays your money, you takes your choice…..

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