Investing isn’t an exact science, and the number of variables affecting the performance of your money can make it difficult to predict a certain outcome. However, you can certainly increase your chances of creating a successful investment strategy by avoiding these common mistakes:
- Focusing too much on past performance
- Using borrowed money for investment purposes
- Not having investment goals
- Not reviewing your portfolio regularly
- Not understanding what you’re investing in
- Not factoring in costs
- Taking too much, too little, or the wrong risk
- Trying to time the market
Below we look at these in more detail.
1. Focusing too much on past performance
This is one of the easiest traps to fall into. People often make the mistake of selecting unit trusts or exchange-traded funds that top the charts over the past year, expecting that they’ll do so in the next 12 months. Just because a certain share or fund (or asset class) has performed exceptionally well recently does not mean that trend will continue. “Some investments have shown positive performance, not because of a clever strategy or good security selection, but because the market has done well and ‘the tide has lifted all boats’,” says Robert Stammers, the director of Investor Education at the Chartered Financial Analyst (CFA) Institute.
“Stay away from simply finding funds or managers that have performed well in the past and look for those whose performance against the market and other competing investments says something about what they may be apt to do in the future.”
2. Using borrowed money for investment purposes
Debt, or borrowed money, isn’t necessarily a bad thing. For example, many people will borrow money in the form of a bond in order to buy a home. But there is a difference between this kind of debt, and “expensive debt” that comes with a high interest rate. Generally it is not advisable to use expensive debt to buy shares (or other equity investments) because it is no use running an overdraft or large credit card balance that costs a lot of money to service while saving 10% of your income. Many financial advisers suggest immediately paying off short-term debt, instead of first rushing off to save.
3. Not having investment goals
“The adage, ‘If you don’t know where you are going, you will probably end up somewhere else,’ is as true of investing as anything else,” says Stammers. “Too many investors focus on the latest investment fad or on maximising short-term investment return instead of designing an investment portfolio that has a high probability of achieving their long-term investment objectives.” As discussed in Goals: Keeping you focused on financial success, creating realistic short- and long-term goals can help you save and invest successfully.
4. Not reviewing your portfolio regularly
“If you are invested in a diversified portfolio,” says Stammers, “there is an excellent chance that some things will go up while others go down. At the end of a quarter or a year, the portfolio you built with careful planning will start to look quite different (from what it did initially). Don’t get too far off track. Check in regularly (at least once a year) to make sure that your investments still make sense for your situation and that your portfolio doesn’t need rebalancing.”
Staying focused on the long term and rebalancing and reviewing one’s portfolio are not at odds with each other. Circumstances change and what’s relevant to you in your thirties is almost certainly not 10 years later.
5. Not understanding what you’re investing in
Know where your money is invested, and how the investment vehicle works. Because of regulatory pressure and a fast-evolving market, there has been a noticeable push in South Africa’s financial services sector to simplify offerings and marketing, which is of great benefit to investors.
And be careful of promises of unrealistic returns. The phrase, “If it sounds too good to be true, it probably is” is particularly fitting when it comes to investments.
6. Not factoring in costs
It is easy to get caught up in performance numbers, particularly given that gross figures are often publicised, in other words, before fees and costs are taken into account. Understand the detail of every cost you’re paying (you are able to ask for this breakdown from your financial services provider) and make sure to consider the performance of a fund or share within the context of your overall portfolio.
What may seem to be small differences in fees (even 50 basis points) can have a significant effect on your returns and wealth in the long term. And always remember to measure your performance against inflation. It’s no use celebrating that 7% return if inflation is running at over 6% because your real returns are barely a percentage point.
7. Taking too much, too little, or the wrong risk
Investing always involves risk. And it’s this risk that, over the long term especially, is translated into some level of reward. The CFA Institute’s Stammers cautions about taking too much risk that “can lead to large variations in investment performance that may be outside your comfort zone. However, taking too little risk can result in returns too low to achieve your financial goals. Make sure that you know your financial and emotional ability to take risks and recognise the investment risks you are taking.”
8. Trying to time the market
When equity markets are rallying, the temptation is there to follow the herd. Conversely, when markets drop, it’s easy to think about heading for the exits too. “Instead of rational decision making, many investment decisions are motivated by fear or greed,” says Stammers. “In many cases, investors buy high in an attempt to maximise short-term returns instead of trying to achieve long-term investment goals.” Focusing on those long-term goals will help the investor stay focused, and ignore the noise of short-term market movements that ultimately don’t have an impact on the end game.