6 common mistakes in investing
If you’ve only got a minute:
- Being aware of common investing mistakes can help you to be conscious in avoiding them.
- If possible, diversify your investments over all major sectors and/or geographies.
- Have a slow and steady, longer-term approach to your investments.
- Put in effort to do due diligence to know your own financial objectives, goals and thresholds, ensuring they are aligned with your investment choices.
Many of us are aware that “hindsight is 20/20”. This phrase refers to being able to look back on past events and see things clearly now that were not clear to us at that point in time. While we are not able to predict the future or have an idea of what it holds, we can benefit by learning from past experiences whether they are our own or that of others.
The same goes for investing. By taking note of common mistakes made by others, you can be better placed to avoid them.
Here are six common mistakes in investing. Do any of them seem familiar to you?
1. Believe in “whispers”
It is often said: “If it sounds too good to be true, it probably is”.
Today, dissemination of public information is so rapid that stock prices react within minutes of the release of new information. Investors who wait for the latest “whispers” in hopes of getting information ahead of others will likely find that the markets have moved ahead of them and priced this in already.
Another type of “whisper” could come in the form of private information – if this is the case, it is considered to be “insider trading” which is illegal, risking hefty fines and/or jail time for both the giver and receiver of such information. As such, “whispers” usually hold little to no value to the one who hears them.
2. Put all your eggs in one basket
Traditional wisdom dictates that having all of our resources in just one possibility is very risky. Diversification is key. There are many factors which could affect the market, no matter how strong your conviction might be on any specific company or sector. Modern Portfolio Theory, written by Professor Harry Makowitz, argues that diversified portfolios tend to do better over time at lower levels of risk.
There are several ways to diversify, including but not limited to:
Holding a portfolio of multiple stocks
While there is no magic number to this, typically a well-diversified portfolio would have anywhere between 20-50 stocks or more. This way, if one or a few of the stocks perform poorly, it would cost a smaller percentage of your overall portfolio.
Carefully selected unit trusts, exchange traded funds or robo-advisors like DBS digiPortfolio can also help you to achieve such diversification goals, especially for investors looking to start investing with a smaller capital.
Holding a portfolio across multiple asset classes
Generally speaking, a balanced portfolio would consist of 50% stocks and 50% bonds. The rationale behind this is the fact that stocks and bonds tend to move in opposite directions to each other thus balancing out the risk levels of the overall portfolio.
Asset allocation differs from investor to investor as it depends on individual risk tolerance and financial objectives, and could also include other asset classes such as cash and commodities.
Holding a portfolio across multiple geographies
Spreading your investment across multiple countries will reduce the risk you take on should something go wrong with the economy and financial markets in one country.
An example of the unpredictability of market movements and benefits of diversification would be during the Covid-19 outbreak. Investors who had diversified portfolios into gold would have balanced out some losses (depending on the asset allocation of the portfolio) from the plunging stock markets in 2020.
More recently in 2022, rising interest rates and bond yields led to investors selling off growth stocks (e.g. technology sector). Those who have invested in tech stocks only are likely to have experienced a greater fall in the value of their portfolios than the average.
3. Trying to time the market
Successfully timing the market is an extremely difficult feat which even institutional or highly skilled professionals often fail to achieve. An efficient market prices in information so quickly that investors are unable to perfectly buy at its trough and sell at its peak.
Besides, many real-world events that shock the markets are completely unpredictable. The Covid-19 outbreak, China’s severe regulation of its tech companies and even Russia’s invasion of Ukraine are such examples.
Investors can take a slow and steady approach to portfolio growth, bearing in mind that history is on the side of those who can wait. The global economy historically sees longer periods of growth than recession, and stock markets see longer “bull” phases (uptrends) than “bear” phases (downtrends).
An option to consider is to buy regularly into the market as and when you have savings to turn into investment capital. You can also invest fixed amounts at fixed intervals - known as dollar-cost averaging, which reduces the risk of having extreme outcomes be they positive or negative ones.
4. Not doing your due diligence
It is vital for an investor to understand themselves - their investment objectives, investment capital, time horizon and risk tolerance levels among other things. These would help to shape the investment decisions made.
You need to know how much you can invest after setting aside savings for emergencies or near-term goals. Investing monies that you might soon need can lead to making stress-driven decisions which are often irrational.
You should also have a good understanding of the investments you are undertaking. This means doing research and questioning advice from finance professionals especially if you are not clear on what has been shared with you.
Whether you are considering straightforward or complex investment options, make sure that you understand all aspects of the product, especially its payoff structure and risks involved.
5. Not taking a holistic approach to your investment decisions
Various financial metrics can play a part in helping you to make your investment decision. However, they often tell very little about an investment when used in isolation.
Take for example the price of a stock. A $20 stock is not necessarily cheaper than a $50 stock, as it depends on what the actual value of the company might be at its current price. A common metric to determine if a stock is over or undervalued is the price-to-earnings (P/E) ratio which compares a company’s stock price against its earnings per share.
Even looking at P/E ratios on its own might not give a fair depiction either. For example, if investors expect both revenue and profits of Company A whose shares trade at a high P/E ratio of 50 to greatly outperform Company B with a P/E ratio of 25, the former might not be overpriced.
This might also be true if Company A has a history of showing increasing earnings each quarter or year. In this case, investors might be willing to pay a premium for taking on less risk, and hence a higher stock price and P/E ratio.
A high P/E ratio might indicate a stock’s price is high relative to earnings and also suggests that a stock is overvalued. However, this might not make a stock a bad buy.
As such, it is prudent to use a variety of financial metrics in order to have a comprehensive idea of the investment you are evaluating.
6. Letting your emotions rule
Stock market returns can deviate greatly over short time span, but historically, returns tend to favour patient and calmer investors over the long term.
Being aware of investor biases can help us make less emotional decisions and better choices especially in moments of euphoria or panic.
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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.
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