Common investment mistakes… and how to avoid them
Financial experts used to think that long-term portfolio performance was due 90% to asset allocation and 10% to timing and selection, but recent studies have shown that investor behaviour can account for up to 50% of the portfolio performance.
Unfortunately, this is one of the biggest risks in portfolio management.
We have identified the most common investment mistakes and ways to avoid them.
Media and emotions
There’s no denying the impact that the media has on our lives. No longer do we have to read the morning newspaper or wait until the 6 o’clock TV news bulletin to find out about current affairs.
Every device we own provides us with access to the most up to date information… we scroll through social media, we stream 24-hour global news channels and we can read articles from any publication whenever we want. Adela Ngai, one of First Financial’s advisers, explains how this can create concern for financial investors:
“One of the most common mistakes that clients make is letting the media be their advisers. We live in an information age so it’s only natural for clients to feel anxious when they are bombarded with bad news every day.”
“The media is very good at stirring fear among investors, but if you base an investment decision on what you see in the media, you might find yourself selling out of panic when the market goes down, or rushing in to buy out of fear when the market goes up.
It’s important to keep yourself informed, but we need to make an investment decision based on facts… not emotions. We don’t always make the best decisions when we panic or when we are worried about missing out.”
Short-term wins vs long-term gains
Another mistake that investors often make is chasing a large immediate return. It is always our aim to create an investment portfolio that is robust and able to withstand market volatility with a constant income return, rather than a quick reward. Adela explains,
“It would be great if advisers could have a crystal ball in their hands so they know exactly when a market will go up or down.
But in real life, most attempts to try and time the market… even by experts, are not particularly helpful in managing long-term performance.
We prefer to focus on long-term gains rather than short-term wins. “
“We are talking about an investment horizon of 10, 20 or even 30 years, so if we have sufficient liquidity in our portfolio and quality assets, we are not so concerned with the day to day fluctuations.”
When someone gives you a ‘hot tip’ on an investment opportunity, it is natural to be inquisitive. But, peer pressure or the fear of missing out might distract you from the fundamental principles of investing. Adela gives us an example of how this can be disastrous for investors:
“Back in 2015, when California was experiencing one of the worst droughts in history, we saw a surge in walnut prices. In less than 12 months the price went from $5 to $12… only to come crashing back down below $5 just 9 months later when the drought broke.”
This type of volatility is exactly what we want to avoid, which is why the First Financial Investment Committee prefers stable investments which produce reliable income streams rather than speculative investments.
The committee continually analyses the market to make sure client investments meet our strict criteria.
As Adela says,
“We don’t need an investment to go up in value by 20% overnight… we just need it to be there in 20 years’ time.”
Not just past performance
Understanding historic performance is important, but it is only one element we need to consider when selecting investments for a portfolio.
This is part of the analysis undertaken by the Investment Committee and gives us greater confidence in the selection we make.
“We can’t drive a car by looking at the rear-view mirror alone and the same goes for investing. We can’t ignore past performance, but we need to see beyond the simple numbers and really ask ourselves…”
“What was driving the good performance, what is likely to drive future performance and how well does that investment fit in my portfolio?’”
Stop losing money
The most common way investors lose money is when they sell out of panic. You’re more likely to make an irrational decision when you panic, and you might be selling an already oversold asset below its fair value.
Lack of liquidity can also cause an investor to lose money because they sell out of a need for cash rather than a clear investment motive. For that reason, our investment philosophy emphasises having at least four years of your income requirement in defensive assets where value does not fluctuate, so that you won’t be forced to sell when the market goes down.