Biggest Mistakes Investors Make
We work with organizations and their employees everyday helping them with their investment decisions when it comes to their Group RRSPs and Defined Contribution Pension Plans. The most common questions we get revolve around what to invest in and choosing the “best” investment.
The unfortunate reality is there is no such thing as the “best” investment and even if there was such a thing, no one has the ability to predict what investment will be “Best” ahead of time on a consistent basis.
Let’s take a look at some of the biggest mistakes investors make.
In my opinion, chasing performance is not only the biggest mistake investors, it’s also the most common mistake.
Chasing performance is where you tend to choose investments that did the best in the past. Quite often we are most influenced by recent performance success. If you saw a list of three investments and the returns over the past year. 3 years, 5 years, etc., which investment is naturally most attractive to you?
For most people, the tendency is to be attracted to the investment that made 15%. Why? Because it was the winner. It did the best and our little hearts can’t help but love winners and hate losers. In fact, most people’s instinct is to sell the losers and buy more of the winners.
Related article: Buy Low, Sell high
According to research I did from my first book Mutual Fundamentals, there is over an 80% correlation that last year’s best performing investments will be the most popular investments. Think back to the Emerging Markets in 1993, Financial Services in the mid 1990s and Technology in the late 1990’s. If chasing performance is your key strategy to selecting investments consider these facts:
- Everything goes in cycles (interest rates, stock markets, sectors, mutual funds, economies, businesses, etc). What goes up can come down. Just because it was the best, does not mean it will stay the best.
- If it were that easy, we would all do it and chasing performance would always work. Well, we all do it but unfortunately, it rarely works.
- Short-term performance is a random walk. It cannot be predicted.
- Chasing performance does not work. According to our research, you have less than a 15% chance that this years top performing investments will be next years top performing investments. In other words, you have a 85% chance of being wrong.
Knowing which sector, market or investment will be the best is impossible. It is just like predicting the future is impossible. Understanding the past is easy. It’s like understanding the technology sector. In hindsight it is easy to understand what happened and why. But back in 2007, how many people predicted there was going to be a financial meltdown in 2008? To take this a step further, if you were one of the few who did get it right, what is the probability that you will get it right again? And again? And again? Just to emphasize my point, what will be the best investment for the next 12 months?
Related article: A tale of perfect market timing
Over and over again, I hear investment and economic predictions not only from everyday people but from smart people and people considered to be professional. The entire industry is built on trying to out predict, out-guess, out-forecast something that cannot be predicted, guess or forecasted.
Investing is a science. It requires structure, discipline, and process. It is not about Ouiji boards, the position of the stars, feelings, intuition or guessing what will be the next best thing (for a while).
Related article: The 5 realities of the stock market
Single dimensional analysis
What are you looking for in an investment? Chances are it has something to do with making money and the more the better. Performance drives investments decisions and why not? We invest money to make money so performance becomes the key determinant of selecting investments. Consider that performance is only one dimension of an investment. While it is one of the most important determinants, it is not the only determinant. Choosing an investment based on performance and performance alone is what we call single dimensional analysis – you are looking at only one aspect or dimension. In other terms, it is no different than buying a car based on color and color alone. Would you buy a car just because it is red? You would not take into consideration, the brand, age of the car, condition of the car, options, etc.
Related article: 5 Essential investment research tips
Far too often, investors look at performance (1, 3, 5 and 10 year returns) without looking at very important characteristics like investment discipline, management fees, taxation, holdings, and risk just to name a few. Proper investment analysis requires good research. Good research comes from multi-dimensional analysis.
No awareness of fees
Fees are a funny topic in the investment industry because most of the fees are imbedded or hidden. As a result, most of the people I meet don’t understand fees properly despite the significant media attention given to fees.
If you are not sure about the fees you are paying in the investment industry, just google any of the following terms:
“Management Expense Ratios”
The bottom line is fees play a significant role in the returns you get from your investments so you have to be aware of the fees you are paying. If a financial institution says you are not paying any fees, they are either lying or completely out to lunch. Every investment has fees and it’s your responsibility as an investor to know what fees apply to you. Please keep in mind that most of the fees are indirect.
Related article: Investors need to pay attention to fees
There are no shortage of investment mistakes but these tend to be the big four that I see often. Do you want to share any other big mistakes that investors make?