![Top 5 Common Investment Mistakes to Avoid](https://www.ibossam.com/wp-content/uploads/2024/08/Blog-21.png)
The French writer Voltaire observed, “Uncertainty is an uncomfortable position, but certainty is an absurd one.” This quote perfectly encapsulates the emotional and behavioural challenges that investors often face.
1. Short-Term Decision Making
Two of the most notorious emotions that influence investors are fear and greed. Panic selling during a downturn or buying into the latest hype rarely leads to sensible outcomes and often results in buyers’ or sellers’ remorse. Sometimes, these regrettable decisions can occur within days or even hours, but the pain from these decisions can last much longer. A crucial question for anyone investing in risk assets is this: Am I a long-term investor, or am I trying to make a quick profit and move on?
Long-term investing involves taking the time to conduct thorough research and due diligence. This doesn’t simply mean reviewing the past five years of investment data. The key to long-term investing is understanding the conditions that have influenced an investment so far and assessing whether those conditions still apply today.
2. Getting Too Attached
While long-term thinking is essential, investors can sometimes become emotionally attached to an investment or its underlying story. It’s important to remember that the primary goal of investing is often to grow your capital. Given that most of us have limited capital, it’s crucial to recognise and accept poor decisions, reassess the facts, and, if necessary, reposition the affected assets. As the old Wall Street adage goes, “Cut your losses short and let your winners run.”
Objective reassessment has become more challenging in the age of social media, where even mainstream media is highly focused on click rates. The more contentious or, in some cases, outlandish the headlines, the more clicks they receive. Investors, even experienced ones, can inadvertently consume information that has no basis in fact. It’s tempting to seek out opinions that support your original investment thesis and dwell in echo chambers, but this can cloud your judgment and erode objectivity. A pertinent example is the behaviour within crypto markets. If you are a Bitcoin believer and the coin experiences a sharp decline, no matter how severe, there is no shortage of chatrooms where you can find reassurance and comfort. However, what is often in short supply in these spaces is objectivity.
3. Inflexible Asset Allocations
While reacting to short-term market movements can be costly in the long term, remaining static in the face of changing market conditions can be equally dangerous. Markets are constantly evolving, and investors need to evaluate new information and ask themselves whether it alters the long-term outlook. Sometimes, market dynamics change rapidly; other times, they develop slowly over an extended period. In either case, investors must be willing to adjust their thinking to reflect the current reality, not just the conditions at the time of the original investment.
A notable example is the shift in the IA UK All Companies sector on November 30, 2021. The market transitioned from SMID and growth-style equities to large-cap value equities. This change coincided with central banks raising interest rates to combat inflation, marking the end of the previous decade’s low inflation and interest rates. From November 30, 2021, to August 5, 2024, 84% of the top-performing funds from the preceding three-year period have now fallen to the fourth quartile, with only one fund remaining in the top quartile. Similar outcomes have been observed across different geographies. In the 1980s, it was all about your Japan allocation; investing elsewhere detracted from returns. Although no one could foresee the end of that trend at the time, it eventually did end, and similar conversations about America are prevalent today.
4. Portfolio Construction, Recency Bias, and Protecting Against Downside Risk
Whether it’s the Tech Bubble of the 2000s, the Nifty Fifty stocks of the early 1970s, or the current dominance of the Magnificent 7, investors have historically flocked to the areas that have performed the best most recently, often at the expense of sufficient portfolio diversification. When things inevitably go wrong, these investors can experience extraordinary losses.
While this point may seem obvious, it’s crucial to understand that portfolio drawdowns have an outsized impact on long-term returns. If a portfolio loses 50% of its value, it must gain 100% just to break even. Therefore, a prudent investor will ensure that all their eggs are not in one basket and will maintain diversification across their portfolio.
5. Focusing on 1, 3, and 5-Year Performance
While placing emphasis on rolling cumulative data periods like 1, 3, and 5 years has become an industry standard, relying on these periods alone does not constitute thorough due diligence. The reality is that no rolling period is anything other than indicative of how an investment might perform if market conditions remain unchanged.
When assessing a manager, it’s essential to examine their performance across multiple market conditions. If an investment has only experienced one set of market conditions, you cannot know how it will perform in a different environment. Much of the last five years have been dominated by large-cap growth stocks in the US, and allocating away from this relatively small cohort of stocks has detracted from returns. Even if you believe that the prevailing conditions will continue, the prices you now have to pay for these stocks are considerably higher than five years ago. The price paid for an asset is a crucial part of an investment case, and the additional risks associated with assets that have seen significant price increases will never be captured by focusing solely on arbitrary rolling data periods like 1, 3, or 5 years.
This communication is designed for professional financial advisers only and is not approved for direct marketing with individual clients. These investments are not suitable for everyone, and you should obtain expert advice from a professional financial adviser. Investments are intended to be held over a medium to long term timescale, taking into account the minimum period of time designated by the risk rating of the particular fund or portfolio, although this does not provide any guarantee that your objectives will be met. Please note that the content is based on the author’s opinion and is not intended as investment advice. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the OEIC fund or discretionary fund management model portfolio is suitable and appropriate for their customer.
Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise, and investors may get back less than they invested.
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