Here are some common (and not so common) mistakes to avoid when investing:
Fees – not understanding what they are and paying too much
It’s important to know exactly what fees you are paying when investing. Some fees such as the brokerage fee, which is based on transactions, may be obvious . Other fees such as Indirect Cost Ratio (ICR), found in managed funds and superannuation funds, are not so noticeable as they are deducted from investment returns before they are declared. Best practice is to manage these fees, however, cheap isn’t always best and it is the after fees returns that tends to matter most.
Diversification – spread the risk and don’t be exposed
Many portfolios are concentrated in one or two investments and are not sufficiently diversified. A diversified portfolio has exposure to various asset classes such as Australian equities, international equities, listed property, fixed income assets and cash. Within each asset class there are also a range of options. Diversification amongst investments and asset classes helps to manage risk by not having all your eggs in one basket.
Local sharemarket bias – ignoring the rest of the world
Generally speaking, Aussies do have a bias for local shares which only make up about 2% of the global share market. This means investors are potentially missing out on 98% of investment opportunities. Investing in a range of asset classes provides exposure to industries and investments that we may not have in Australia. Being too focussed on Aussie stocks can have a detrimental impact on returns and increase the risk over the long term.
Cash – too much or too little
When the markets are volatile, and investors are nervous there is a natural tendency to either cash in a portfolio or to delay investing altogether. Holding too much cash, earning little or no interest, can be a drag on portfolio performance, leading to disappointment. There is merit in having some cash which can provide protection and stability in a portfolio. It is also worth having cash to assist with short term requirements and cover emergencies, but too much cash is not typically a good thing.
Emotions – letting them get the better of you
Investing can be counter-intuitive: when the market is rising there is an element of FOMO (fear of missing out) and the urge to invest is strong. Afterall, how could anything possibly go wrong? When the market is in free-fall the natural desire is to protect the portfolio and either reduce exposure to shares or cash out entirely. Interestingly, savvy investors should be doing the opposite. That is, taking profits in strong bull markets and investing when there seems to be little hope – buy low, sell high.
Not having a plan – a goal without a plan is a dream
Smart investors don’t invest without a strategy, a goal, a timeframe and discipline. It’s easy to be reactive to events when there is no real purpose in investing. When investors know what their goal is (for example, retire in ten years or purchase a holiday home in five years) it focuses the mind and helps when challenges arise. Investors without a clear plan can easily be seduced by the next big thing (crypto, hot property, gold) and lose sight of the big picture.
Risk – it’s not all bad
Life without risks would be boring right? The same can be said about investing, particularly for the long term. A common mistake is being too cautious and investing in a very cautious manner. That’s ok if your goal is to preserve and protect your assets. However, if you are growing your nest egg, then some risk needs to be incorporated in the portfolio. Risk means different things to different people, although most people associate it with loss of capital. If you’re investing for the long term, there are bound to be times where returns are low or negative but time is on your side and well-constructed portfolios generally recover over time.
Tax – don’t let the tail wag the dog
Most people don’t like to pay more tax than they need to; a common mistake is making long term investment decisions guided by tax implications. You should be smart about taxes and understand the tax implications of investment decisions, but those decisions should be based on their merits, not solely on tax. Investors have fallen foul of tax effective investments, lured by upfront tax deductions only to lose everything due to the poor quality and structure of the investment scheme.
Review your portfolio – but not every day
Looking at your investment portfolio too often can lead to an over-reaction and unnecessary trading. Investors don’t like losing money and studies show that excessive trading can detract from portfolio returns over time. On the other hand, having a set-and-forget strategy for years on end is not the ideal approach either. Depending on your timeframe, portfolio, and reasons for investing, reviewing quarterly or even annually might be sufficient.
Knowing even a few of these common mistakes that can be made when investing, can not only build confidence but help you avoid making costly mistakes of your own.
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