Six common mistakes in investing
“Hindsight is 20/20 vision”, as the saying goes. While nobody can tell you what is around the corner, the benefit of experience can help you deal better with the stuff that could be around the corner. Here are six common and arguably most costly mistakes in investing.
1. BELIEVE IN “WHISPERS”.
The belief in the whispered “hot tip” is the most toxic and costly of mistakes an investor can make. It destroys value in two ways. Firstly, it delays the process of investing in the future by making would-be investors wait for that “big one” that could make them rich. Secondly, you will more likely end up losing money trading on “whispers”. The dissemination of public information is so rapid these days, stock prices react within minutes of that information release. By the time the whispers get to you, it’s hardly “hot” anymore. It’s already “in the price”. And don’t seek non-public information either. There are no free lunches in life. Somebody pays. Why would anybody give you a real “hot tip” when he could make money for himself on the quiet? By the way, giving and trading on real “hot tips” is a crime – it’s “insider trading”. Both tipper and tippee risk hefty fines and even jail time.
2. PUT ALL YOUR EGGS IN ONE BASKET.
No matter how much conviction you have in one or two stocks, you could either be wrong or “bad stuff” sometimes just happens to even good companies. So, diversify. There are three ways to do so. A) Spread your single stock risks by having a portfolio of at least 20 stocks. Even a 20-stock portfolio is considered a “high concentration portfolio”. One bad stock could cost you 5% of your portfolio. More typically, a diversified portfolio could have up to 50 stocks. If you don’t have enough capital to buy that many stocks, consider a unit trust or an exchange traded fund. B) Spread your investments across two or more asset classes – stocks and bonds, maybe commodities too. Again, if you can’t have that many investments, you can achieve asset class and securities diversification through unit trusts or exchange traded funds. C) Spread your investment across geographies. There will be times when certain countries do better than others. If you are invested throughout the major markets, you again lower your concentration risk. Modern Portfolio Theory, written by Professor Harry Makowitz, argued that diversified portfolios tend to do better over time at lower levels of risk.
3. TIME THE MARKET VERSUS TIME IN MARKET.
There are those who buy regularly into the market as and when they have savings to turn into investment capital. And there are those who try to time every market wave – trying to get off the wave at the top and get back at the bottom. We cannot discount that there are highly skilled professionals – with access to very sophisticated financial data systems – who can get such moves right more than half the time. More often, market timers get “whip sawed” by market moves – that is, selling too early and then chasing stock upwards too late in the cycle. The “time in market” approach demands discipline – especially during “bear” phases during which prices fall more than 20%. But history is on the side of the “time in market” investors. The global economy historically sees longer periods of growth than recession. And stocks markets see longer “bull” phases than “bear” phases.
4. MISMATCH BETWEEN INVESTMENT OBJECTIVES AND TIME HORIZONS.
This is related to mistake #3. Often investors start with good intentions to stay long-term but get cold feet and sell at the first sign of trouble – often at a loss. There are active traders – highly skilled, very nimble, with time and resources to throw at the job – who attempt to make money over short time frames. But if your objective is retirement in 30 years, what’s your hurry? We go back to the point above in #3 about “time in market”.
5. FAILURE TO QUESTION FINANCE PROFESSIONALS.
Doubt when anything is not clear. And ask when in doubt. For example, if you’re investing in a unit trust, check the fund’s performance as far back as data is available. What is the track record of the fund? Did it beat the underlying index (so, if the fund is invested in Singapore stocks, the underlying index might be the Straits Times Index)? Indeed, did it beat the underlying index sufficiently after discounting the sales charge/redemption fee? In a 2016 survey, Standard & Poor’s found that less than 1 in 5 global equities funds it monitored outperformed their underlying index over the prior 15-years. Similarly, if you’re offered complex options-related derivatives, make sure you understand all aspects of the product – its payoff structure and risks
6. FAILURE TO UNDERSTAND RISKS.
#5 leads to this final point. Investors too often look at the potential returns without considering the risks. Risks always – and we repeat, always – rise in tandem with returns. Once again, we are back to the point “there is no such thing as a free lunch”. Similarly, there is no such thing as a high returns investment without high risks. So, when you are offered a high yielding investment, make sure you understand all the risks.
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