Five common mistakes made by investors
Successful investing demands discipline and self-control, new investors are often unaware of the extent of the impact their emotions may have on their investment decisions.
By pointing out five common mistakes, the potential monetary impact and solutions for investors to overcome them, this article will set equity investors up for a long investing life.
Mistake 1: They don't plan
One of the biggest mistakes that investors make, is to not think about their overall strategy, before they begin trading. A sensible strategy for any purpose needs to set out a goal and the means of getting to that goal.
An investment plan should include the following:
• Investment objectives – this might be something as simple as “To maximise returns from the investment” or as specific as “To achieve a medium-term return of inflation (as measured by the Consumer Price Index) plus 3.0% per annum over a rolling five-year period.”
• Risk profile – It can also include the investor’s risk profile with a statement such as “The portfolio will aim to avoid any more than two years negative return in any five year period”. Or if the investor is more risk averse “The portfolio aims to avoid a negative return in any one year.”
• Investment timeframe – An investment strategy should also include an investment timeframe, which will be heavily connected to the investment goal. For example, if the aim is to build a deposit for a home, the time frame would be much shorter than if it were for wealth creation for retirement.
Mistake 2: They fail to diversify
Failing to diversify across more than one company or asset class is another big mistake that new investors make.
When it comes to equities, a stock portfolio of between 10 to 20 stocks is a good benchmark for sufficient diversification. Less than 10 stocks may not provide sufficient diversification in a portfolio, while more than 25 may be too hard to monitor.
A well-diversified equity portfolio should consider sector allocations of the S&P/ASX 200 - the benchmark index for the Australian Securities Exchange (ASX) – and have similar weightings to each sector.
Mistake 3: They don’t do enough research
Even investors that create detailed investment plans sometimes get caught up in ‘tips’ heard at the water cooler or from a taxi driver, or a rapidly accelerating share price.
It’s important to conduct thorough company research. Read a company’s annual report and financial statements and find out how brokers rate them. Keep an eye out for the company’s announcements and watch for trends in results.
Mistake 4: They overthink and hesitate
It is possible to do too much thinking about a potential investment and choice paralysis is a very real and documented phenomenon in investment psychology. Studies have shown that the more choice people were offered when it came to choosing an investment, the less likely they were to make any investment at all.
However, by not making an investment at all, an investor could have been passing up thousands of dollars a year.
If an investor doesn’t have the confidence to buy individual stocks, one good way to become familiar with the sharemarket is through purchasing exchange-traded funds (ETFs). ETFs are essentially little pieces of each share represented in a broad market index, and therefore a good, cost-effective way of buying a large amount of shares at once. They are an investment in the market (or sector) direction, rather than the outcome of a particular company.
Mistake 5: They don’t consider the big picture
Many investors do their individual company research and write an investment plan but they don’t always consider what the future holds for industries.
Savvy investors need to be across not just current industry-wide issues but possible future developments as well. For example, disruption is a big issue in many industries. Uber and Airbnb are just two companies that have managed to enjoy huge success by disrupting existing business models.
Investors need to connect the dots around changing demographics, consumer behaviour patterns, and technological developments and what that might mean for particular industries and companies.
Investing in new trends carries risk but it also provides the potential for great rewards. A core/satellite approach can be useful when it comes to investing in new trends. An investor could allocate 10% to 20% of their portfolio to companies “thinking outside the square” while investing the remainder in larger companies or ETFs. Such a sensible approach to risk management would mean a loss in one or two cutting edge companies won’t cause a huge loss to the overall portfolio.
All prices and analysis at 6 July 2021. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.