Common investment mistakes

Chasing last years winners / Being afraid of missing out

If something – such as a particular fund, asset class, industry sector, fund manager, company or similar – has been performing really well recently it is, unsurprisingly, tempting to invest in that. We are inundated all the news about how great asset class XYZ or companies in sector NNN are doing, and we feel excited and also fearful of missing out. Even when the history of great performances is very short, we want to believe that this is just the start of something that will prove to be amazingly super-excellent in the long run.

In reality, short-term greatness doesn’t necessarily translate into long-term or even mid-term greatness. Also, if the thing you are thinking about investing in is already highly popular you are likely to put your money in at or near the top of the market. Without you knowing it, the asset might already have reached the point where the smart money has started to move out and only the dumb money is pouring in.

It is easy to be swept away, and the feeling that you are missing out on great returns can be very powerful. However, that feeling has been the cause of m a n y horrible investment decisions – including quite a lot of investments in what turned out to be ponzi schemes.

Not diversifying

All investments are risky. One way of mitigating risk is by diversifying. Instead of putting all your eggs in one basket, you spread them out.

Most of us already know this and agree in theory, but for some reason it can be quite difficult to actually carry out in reality. You get that super tip about investing in this up and coming biotech company and swoooch – 70% of your eggs is placed in the same basket. Or you r e a l l y want to buy that beautiful beach house and start convincing yourself that real estate is the best investment in the history mankind and placing all your eggs in that particular property is the right way to go.

When you diversify, make sure you diversify in several different ways. If you for instance by shares in several different companies, but all those companies are based in the United States, you have diversified when it comes to companies but not when it comes to country.

Using the wrong financing

Never use pay day loans or other similar loans to finance your investments. Picture from snabblåna.com

It can sometimes be a good idea to borrow money from a bank to invest. By borrowing money you can earn more money than you otherwise would be possible.  Using external finance to leverage your profit can be a good idea as long as you do not leverage yourself to highly.  It is very important that you use the correct types of loans when you borrow money to finance your investments. If you choose the wrong loans it can be almost impossible to make good investments.  You should avoid all types of high interest loans such as payday loans and other fast loans.

Not shutting out the chatter

During an average day of you life, you are probably bombarded with tons of “investment advice”. Some of it will be outright, some of it will be disguised as something else. While it is pertinent to be an informed investor, it is also important to cultivate the ability to shut out the chatter. If you jump every time some self-proclaimed financial expert tells you to, you will spend your life in a state of constant bouncing and you are not very likely to get rich doing it.

Only listening to finance experts

If you want to know what to invest in, you need to seek the advice of finance experts, right? While it is true that finance experts can have good advice, it is also true that in order to spot something before anyone else you can not look in the same direction as everyone else.

Many successful investors spend more time exploring other things than they do seeking out financial information and advice. Let’s say for instance that you are interested in investing in biotech. Actually learning more about the science behind recombinant gene techniques, biorobotics or single-nucleotide polymorphisms might be more helpful than listening to the advice of yet another business school guy.

Not studying the local market

A common mistakes made by many investors is to not learn enough about the rules and regulations in the foreign markets where they invest. The local rules that regulate the trade in different financial instruments and other investments can have a large effect on your bottom line.

• As an example can be mentioned that it is important to know about the tax regulation in the country where you invest. Some countries tax all profits made from investments in their country. Other countries allow you to collect your profits from  investments without having to pay tax in the country where you invested.  You can usually find the tax regulation in a bilateral tax agreement between your country and the country where you want to invest. That agreement will be available in your native language and can be found online.
• Another example of something you should know before you invest is how and when the dividend is paid. The best way to find information of this type is usually to visit a local website focusing on the market you want to invest in.  If you want to invest in Sweden you might visit a Swedish website such as Realfinans. If you want to invest in Bulgaria then a Bulgarian website will be the best option. If you don’t speak the language in the local market where you want to invest then you will usually have to rely on less reliable English websites.

Overconfidence in money managers

Several studies, including the famous “Returns From Investing In Equity Mutual Funds” by Burton Malkiel (1995), have shown that most professional money managers will underperform their benchmarks. In essence, you are paying someone else a lot of money to perform worse or an par with index.

Over the long-term, placing your money in low-cost index funds will typically give you a better return than what 65%-75% of actively managed funds will give you. Of course, having put your money in those actively managed funds that outperformed the low-cost index fund would have been even better, but it is notoriously difficult to know in advance which funds that will be. In this case, past performance is not a reliable indicator of future results. It easy to fall into the trap of thinking that an actively managed fund that has performed great in the past – and that charges huge fees – must be a great fund, but there are no such guarantees.

When it comes to professional money managers, we should also take into account that they normally mange several funds. When one of those funds outperform the market for a period of time, the manager is hailed as the golden child of money management. When the rest of the funds underperform or perform on par with index, it is not seen as the result of poor money management but the outcome of a long row of other factors, such as general industry conditions, changes in legislation, and so on.

Remember – no one will look out for your money more than you.

Having a rigid self-image

We humans tend to be fond of labeling ourselves. I’m not a risk taker or I’m a daredevil. When it come to investing, it is advisable to let go of those labels and realize that you can be both Mr Madcap and Mr Play it Safe – just with different investments. By diversifying properly, you can let different aspects of you personality be in charge of different investments.

Meddling too much with your investments

Do you want to invest, or do you want to trade and speculate? Trader and speculators are constantly moving their money around, trying to make a profit from tiny market fluctuations, small arbitrages and similar. To make a profit this way will typically requires a lot of time, devotion and insight.

If you don’t have those things, you are probably better off investing. Design a portfolio that is suitable for long-term investments and do your best to refrain from the constant meddling. Of course, exactly how long long-term is depends on your goals. Are you investing for a retirement that is 30+ years into the future? Or are you investing to help your kid out when she starts college in 5 years?

A great way of destroying your financial well-being is to treat the stock market (or any other market you invest in) like a casino where you are chasing short-term wins on the slot machines. Try to think like a casino owner instead of a casino guest – what you want is a steady return on your investment. Some days you will be up, some days you will be down, but it is long-term performance that should be your focus.

Of course, this doesn’t necessarily mean that you should put together a portfolio and then make absolutely no changes to it for 30 years. There are several smart ways to actively manage an investment portfolio without turning into a day trader.

Not realizing that your broker wants you to make as many transactions as possible

Many brokers are trying to sit on two chairs at the same time – they are both brokers and providers of financial advice.

A common investment mistake is not realizing that most brokers have a business model where they make money every time you make a transaction. Because of this, they have a vested interest in encouraging you to move your money around a lot. It doesn’t really matter that much of you win or lose – they get their cut regardless. This is one of the reasons why they bombard you with lots of “new” investment advice, the latest tips, the in-the-know rumors, etc. They don’t just want you to invest more money with them, they also want you to move it around a lot.

Trading isn’t free. It comes with a cost. Sometimes that cost is the fee you pay your fund manager, sometimes it is the fee you pay your broker, and sometimes it is something completely different – but it is always there and it must be factored in when you make investment decisions.

Buying high and selling low

We all want to buy low and sell high. So why don’t we? No one is stupid enough to believe that buying high priced assets and then selling them off at a lower price is a good idea, but we still see people doing this all the time.

When prices are high, it is easy to get drawn in and buy. As mentioned earlier in this article, it is very tempting to follow the market and chase the latest fling. A lot of people by at or near the top, when the smart investors have already begun to pull their money out. When the prices start to go down, people panic and sell off to cut their losses. They are – tada – buying high and selling low.

Conversely, many people dislike investing when prices are low. When prices are low because of a general economic downturn, a lot of people will be disenchanted with the financial markets in general and avoid investing (especially if they have lost money recently). When shares in a certain company is low, e.g. because that industry isn’t considered very “sexy” right now, they will avoid that industry because, well, it isn’t exciting and none of the expert advice they are getting is telling them to pour their money into Boring Inc.

If you buy the same assets as everyone else is buying, it will be very difficult for you to outperform the market unless you timing is impeccable.

Not making investments a priority

For many people, saving and investing is not a priority. They get their pay check, pay their bills, spend throughout the month and then complain that they “can’t afford to save or invest anything” because there is never any money left over by the end of the month.

One way of getting around this hurdle is to have a pre-determined amount of money moved automatically from your regular account to your savings account as soon as you pay comes in. See it as just another bill that must be paid. You are paying a bill to your future self.