The Magnificent 7 (ways to lose money) !
I completed a B.Comm degree in 1984 and went in search of a job. I got one in the insurance industry and have been involved in this industry since – 33 years. That’s a long time!
Like many industries, I’ve witnessed radical changes, most, thankfully for the betterment of investors, but unfortunately despite all these improvements, I continue to see investors repeat the same mistakes since I first started back in 1984.
What I’d like to do, is to give you a flavour of these mistakes. You can significantly boost your changes of investment success by being aware of these mistakes and taking steps to avoid them.
1. Plan: Fail to Plan and Plan to Fail
Everybody is different but everybody needs a plan. As the old saying goes; “if you don’t know where you are going, any road will take you there”.
You’d be amazed at the number of people we meet who have no plans.
A plan can be as simple as having enough in a child’s college education fund or accumulating €2 million into a retirement fund.
Clearly financial planning is a real challenge for people because this involves multiple time periods over an uncertain future.
Plans can be short, medium or long term.
The great challenge in life is to stick with the plan, particularly when current market conditions are unsettling.
Having a good plan and sticking to it, is not nearly as exciting or as much fun as trying to time the markets, but it is far more profitable over the long term.
2. Understanding Risk and distinguishing between risk & volatility
Risk and return go hand in hand.
The longer the time period you can afford to invest, the greater the risk you can take and the greater the return you will make.
If you are a c. 30-year-old saving for retirement over say 30 years, you can afford to take risk.
People confuse risk with volatility.
Volatility is the journey. It can and will involve temporary declines. The trend is overwhelmingly positive over the long-term, therefore volatility will iron itself out. It shouldn’t be a meaningful risk but if puts panic into the minds of investors.
Risk is a permanent loss of capital. This is a situation where for instance, a company goes bust and shares in that particular company become worthless. We regularly see the stock market move up and down, but the market itself doesn’t go bust.
I’m a keen cycling enthusiast. For the past number of years, myself and a few friends take on a cycling challenge. This invariably means climbing up and down huge Cols or mountains in France. So, you could say that it’s a volatile journey but the big risk is actually coming off the bike, falling and causing serious injury. It’s not riding the ups and downs (hard and all as they are).
3. Too short a time horizon
If you are saving for retirement in 20 years’ time, what the stock market does this year or next year shouldn’t be the biggest concern.
Even if you are just at the point of retirement and going to draw down your funds, your life expectancy is likely to be 30 years.
So, we need to become more long term in how we think of investment.
This will allow us to ride out the storm. Invest in greater growth assets. Ultimately we will get a better return on our funds. This is demonstrated by the example of the most unfortunate investor, who invested into the US Stock market in June 2007. Imagine, it’s your absolute horror scenario because that investor would have seen their investment value drop by over 50% in the next 18 months. Their €100k investment would have dropped in value to under €50k. However, if they stayed in the market and rode out the crises, that €100k is now worth €200k today, 10 years later. So we see, it’s time in the market, as opposed to timing the precise point of entry.
4. Reacting to News
People pay too much attention to media or react too quickly to bad news.
We live in an era of constant news feed. In a former time, we got our news from newspapers and TV. Nowadays we are under siege from every social media platform available
Facebook / Twitter / Instagram as well as De Telly
News is designed to provoke a response. To provoke a reaction. News is all about headlines and reacting to news. Second guessing the markets and making short term news driven reactions will move investors away from their plan will invariably result in a poorer investment outcome.
A study in the US, showed investors underperforming their own investments by almost 50%. So, if funds were producing 8% p.a. over 10 years plus time period, investors were only getting a 4% p.a. return because they were switching into and out of the market.
5. Inappropriate asset allocation for investment time horizons
An investors asset allocation needs to reflect the time horizon for their investment.
As mentioned already, the longer the term, the more risk one can assume, the better the investment outcome.
Currently, with low interest rates, we see investors locking up funds for 5 years plus just to get a guarantee of 90% back. They sacrifice huge upside just to have downside protection. Adopting a more fluid time frame will permit a greater risk acceptance and more appropriate asset mix to achieve their planned outcomes
Rebalancing is the process of returning your portfolio to the asset allocation agreed at the start of the journey or plan.
Rebalancing is difficult because it forces you to sell the asset class that is performing well and buy more of your worst performing assets. This contrarian action is very difficult for investors, but it is the very action that will save you from wealth destruction and protect your funds.
6. Lack of Diversification
Don’t put all your eggs into the one basket is a phrase that’s popular; but how many of us were caught up in the
– Property mania in the first part of this century or
– Piled into Internet Stocks or bought bank shares only, or
– Have all our funds tied up in the bank
A properly diversified investment portfolio will protect you from
– Wealth Destruction and
– Insulate you when the economic waters get choppy
– Equally will give you exposure to markets, so that you can take advantage of the longer-term gains to be achieved.
You don’t need to gamble on the next bitcoin crypto currency to get rich slowly
7. Bad or Mad Investor Behaviour
This is probably the greatest and most frequent sin that is committed.
Believe it or not, but investors are their own worst enemies.
The dominant determinant of financial outcomes is investor behaviour.
People respond inappropriately to Financial Stimuli. They get aggressive at the top of the market and panic at the bottom. Investors change their investment composition too frequently and invariably often after the horse has bolted.
In my 33 years, I’ve witnessed time out a number of investors switch out of the market to a safe Cash fund at the bottom of the market, because they lost their nerve, only for the market to soar immediately afterwards. This ground is never recovered because human nature makes it too painful to go back into the market.
Occasionally I’ve seen investors time their exit to perfection but missed the subsequent rise because inertia kicked in and they couldn’t get back into the market.
Fund Managers in Ireland and elsewhere in the world will attest to the fact that the greatest number of switches out of Equity type funds into safe Cash funds, occurred in March 2009, just as the market was turning back upwards.
We see investor envy drawing people into investments too late, too dear and just not right – like buyers in investment property in 2007.
We see investors sell low to buy high; the exact opposite to what they are supposed to do.
We see investors chasing Alpha or outperformance instead of choosing their planned outcomes. So they buy the latest star share or glamorous fund
In a performance mad age – you don’t need to be a hero. Being Boring but Brave – much like Warren Buffet, will get you to where you need to be and where need to go.
In fact, the greatest service we can provide to our clients is to act as their behavioural investment counsellor
Our job is to keep our clients on track with their plan regardless of the fads or fear that will arise.