The 3 biggest mistakes investors make

The 3 biggest mistakes investors make

12/1/2020

The average performance of the 500 largest US companies (Apple, Microsoft, NIKE, Starbucks, Amazon...) was 10.2% per year over a 30-year period (see figure below). However, the average return for an investor invested in the same index was 6.2% per year lower, a mere 4.0% per year. Sure, there are some costs associated with investing, but still... If those fees were 2% per year, that's still more than a 4% difference in the return of the average investor versus the return of the index as a whole. That's a lot of money over a 30-year horizon! What could it be?


Sure, you might say, there are costs associated with investing... But even if those costs are 2% a year, the average investor still loses 4% compared to the index as a whole. And over 30 years, it adds up.

So why do clients lag so far behind in appreciation?

The answer is simple: the investor is human and makes mistakes. His decisions are not always rational, but rather driven by emotion.

What are the most common mistakes investors make? 

MISTAKE NO. 1INSTEAD OF INVESTING, THEY SPECULATE

Investing is not about buying cheap and selling dear. That can happen, but in most cases it doesn't. In the capital market, everyone has the same information, it is foolish to think that I will be the one to take over the market. Moreover, frequent buying and selling only makes investing more expensive (not to mention taxing) and benefits the investment broker rather than you. It's also not good for the plant if you're constantly replanting. It needs time to flower and fruit. So do investments. They benefit more from investor inaction than the opposite. 

ERROR NO. 2 NOT STICKING TO A LONG-TERM STRATEGY WHEN THE MARKET FLUCTUATES A LOT

The value of a properly diversified portfolio grows over time but fluctuates. It is a phenomenon that is specific to investing and inherent to it. To see this upward trend, it's not enough to invest for a year or two... The fluctuations are greater the more dynamic the portfolio is or the higher the percentage of stocks it contains. Higher volatility in quality securities corresponds to higher expected returns. Bonds fluctuate little, but will give us less appreciation over time. In downturns, we need to keep our nerve and take advantage of these downturns, for example, to buy shares at lower prices. The portfolio will then grow that much faster. If, on the other hand, the market is rising like crazy, it is better to spread the investment out so that we do not buy at high prices and risk an early decline.

This may also be the investor's thinking…

ERROR NO. 3 BETS ON ONE CARD

Many investors are picking individual stocks in an effort to find the next Apple, Tesla, or Amazon. The probability is higher than in sports, but not by much. In these cases, the risk of a client crying over earnings is really high. We all know the story of NOKIA. Its stock has gone from an absolute peak at the turn of the millennium to a near-zero value after a decade. The distribution is key to the portfolio, on several levels. The allocation to equity and debt securities (stocks and bonds) defines the dynamics of the investment. Allocating the equity component in terms of sector, company size and geography, and allocating the bond component to government, corporate and high yield bonds limits risk. Most importantly, the portfolio allocation is based on the investor's investment profile, i.e. what experience he has in investing, what financial background he has and what fluctuations in value he is willing to handle.

The reality is that clients are harming rather than helping themselves by their activity. Avoiding these mistakes is the goal of our work with clients. We recognize that portfolio performance is not so much dependent on how the markets perform, but rather on investor behavior.

Wondering how to avoid making bad investment decisions?

Do not hesitate to contact us

Contact

Ing. Petra Štěpánková, MBA, EFA

+420 604 218 602

petra@meliorinvest.cz

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