Here we are at session number 43 , and we’re going to be talking about some classic investing mistakes and how to avoid them.
In my 16 years as an adviser, I have witnessed people make some blinding mistakes with their investing, some of which have seriously damaged their future wealth prospects. In this session I’ll be listing nine of these investing mistakes and discussing how you can avoid making them.
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I’ll shift a bit from the usual format of dealing with what you need to KNOW first and then dealing with what you need to DO afterwards. Instead I’ll deal with each mistake and how to avoid it in a complete section of its own.
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Also after the main body, I’ll answer a question from Philip about the Help to Buy Scheme and we have a new segment to the show which is the glossary – I take a phrase or word from the personal finance world and define it for you in my own inimitable way!
But before we dive in to the main content…
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Before Christmas in Session 41 I talked about building an investment portfolio from scratch. It was one of the most popular sessions I’ve done in a while, and one of the points in the first half of the show was that investors are their own worst enemy. Often, decisions are made where money is concerned which would be obviously daft in any other situation.
I suppose this is understandable. We can’t live without money, at least not comfortably, and so we’re very protective of it, and rightly so. But sometimes in doing what we think is the right thing, there are so many possible pitfalls that often we end up doing the wrong thing entirely.
The following mistakes are ones I see made frequently, usually not after someone becomes a client, else I wouldn’t be doing my job properly, but before I get my hands on them!
Before I forget, you only really need to remember one link and that’s for the shownotes for this session. Everything you need is there including all the notes and any links I mention. It’s also the place to comment on today’s topic if you want to.
Nine Classic Investing Mistakes
1 – Trying to time the market
I’ve talked about this mistake a time or two here on the podcast. There’s an adage that investing is not about timing the market, it’s about time in the market. That’s true, and yet we still think we can do it.
This mistake takes a couple of forms, but they are both insidious in the way they will erode the returns from your portfolio.
The first is bailing out at the wrong time. Maybe markets are having a rough patch or you read something in Moneyweek about the US going to hell in a handcart. And so you pull some or all of your money out and breathe a sigh of relief about how smart you are. Now it may be that markets continue to slide and you made the right decision in the short term, but it can just as easily go the other way.
Immediately following this comes the second form of this mistake – not knowing when to go back in to the market. I have seen this happen soooo many times. I have one client who pulled half his money from the markets in late 2007 and saved himself a good chunk of losses in 2008 and early 2009. But he was a year late going back into the market and missed something like 75% growth on that money. That’s gotta hurt. He would have been better off hanging in there throughout both he down and the up. He didn’t need the money for anything in particular, he was just – understandably – concerned about losing it. But in the end he ended up losing out on growth, which is much the same thing.
How to avoid this mistake: Realise that you have no idea what is going to happen. That’s why they always tell you that past performance is no guide to future performance. Better by far to hang in there for the long term. You do know how long you’re going to be investing for, right? We’ll get to that shortly actually. You should never invest in risk assets for less than five years, and ideally for seven or more.
If you are investing and saving towards a specific end point, such as retirement or sending your kids to university, you might want to reduce the risk of your investments as you near the end goal. This is called lifestyling and involves gradually reducing the risk from say five years before the end point to reduce the impact of nasty market shocks in the last period before you need the money.
The money should also be invested according to your tolerance for risk, so you should be aware of the kind of volatility you might expect and not be tempted to try to time the market.
2 – Insufficient diversification
Another schoolboy error this – you should know better! Eggs in baskets and all that – you must spread the money around to reduce the risk. A couple of manifestations of this mistake are as follers:
- Having too much money in the UK. I know that it is a market that we understand better than the others, but the UK represents something like only 8% of the world’s stock markets. There is literally a world of value out there you could be tapping into.
- Venerating a single fund manager/fund house. Yes, I’m looking at you, Neil Woodford groupies! Neil is just about to leave Invesco Perpetual after heading up its equity investment team for donkey’s years. He is a superstar investor, no doubt, but he’s not the Messiah. The furore when he announced his resignation was to be expected, but still daft. I had a client once ask me to liquidate his entire portfolio, which we had invested just a few months before and reinvest with Woodford. We parted ways over it – it was a moronic idea.
All the research points to the fact that Asset Allocation, or the amount you have invested in each geographical location and asset class, is the biggest determinant of the range or returns you’ll get. I talked about Asset Allocation back in Session 41 [LINK] so head over there to listen more about that. But not till I’ve finished up here.
How to avoid this mistake: Put simply – get more baskets! If you are investing yourself and not taking advice, then I would take a top-down approach. That is, set the amount you want in each asset class first and then choose your funds. I would use tracker funds or ETFs to invest, rather than try to find the best managers, but if you prefer active investing, then so be it.
If you have a decent size fund you may want to subdivide each asset class further. So for example. If you have a £200,000 investment and want to invest £40,000 in the UK equities, you could consider small-cap equities, large-cap equities, recovering companies, value based funds and growth based funds, all sorts.
Spread the money around and rest easy in your bed. Asset Allocation is a skill, no doubt, and in my opinion, one best left to the professionals. But whether you do that, or do it yourself – DO IT!
3 – Switching too often
Lets say you have chosen a bunch of funds for yourself, mapped carefully to the perfect asset allocation. If you’re that actively interested in your portfolio, then you’re probably scouring the performance tables in Money Management each month. Would you believe it?! The top fund that you chose three months ago has dropped to the third quartile over the past year! Clearly the fund manager, that a short while ago was the best thing since sliced bread, has become a moron overnight. Quick! Action must be taken! So you switch out of that fund and into the current top dog and you’re very pleased with yourself.
Stop! You are doing damage to your returns. Chances are you have dealing fees each time you switch and this is costing your real money. Even if you’re invested in an environment where there are no fees for switching, there is little logic in constantly switching from one fund to another. All managers have weak periods. Any investment decisions should ideally be made on the strength of a good length research period.
How to avoid this mistake: Assuming you’re invested in active funds, give your managers time to do their thing. I would set aside some time each year, maybe in the summer when markets are quietish, and really drill down into the performance of each of the managers in your portfolio. Compare them with peers. If they seem to be underperforming, look more closely into why this might be the case. Has your manager taken a conviction position which has yet to bear out? Read the performance updates issued by the manager which will explain what decisions have been made and whether or not they have been justified.
A classic example of world-class managers having ‘duff’ periods was in the late nineties when that man again Neil Woodford refused to buy into the technology stocks that so many of his peers were piling money into. His shorter-term performance slipped to fourth quartile and he was slammed in the investing media as having lost it.
New Year 2000 came around and for the next three years technology stocks plummeted. Some funds lost 90% of their value. Woodford stayed invested in ‘boring’ stocks that had served him well, and surfed the wave back to the top. Like I say though, he’s not the Messiah, just a very good fund manager. The point is that if you dropped him in late 1999 you’d be feeling pretty stupid in late 2000.
Short-term performance is largely irrelevant – look instead at the long term performance of your managers and give them time to perform.
4 – Watching the portfolio too closely
Investing, as I believe I’ve said a time or two, is a long-term game. So why are you logging into your portfolio every six hours to see how it’s doing?!
I exaggerate. You’re only checking every day. No! Stop it! I can see no justification whatsoever to check the performance of your portfolio more often than once a month. It serves no purpose other than to worry you unduly. If ever I have a client that calls me ‘too’ regularly, concerned about the small ups and downs in their portfolio value, I guarantee they are checking more regularly than this. The vast majority of my clients don’t check from one six months to the next. They are content to let me look after things for them in the knowledge that if anything goes awry I’ll be in touch.
This is possible if you’re investing yourself too. Even though there’s no-one to leave things to when it comes to day-to-day management, if you have invested wisely, for the long term, then you should be able to let the portfolio run without watching it too closely. If you let the short-term fluctuations panic you into making investing decisions, you’ll regret it.
How to avoid making this mistake: Don’t watch your portfolio too closely! Discipline yourself to check it only once per month. If you hear about terrible thing happening in the news, then you have permission to check in, but, remember mistake no. 1 – are you going to make a rash, short-term decision? Nope, you’re not, because you have listened to this session. Instead, you’re going to check in, not panic, and go about your business.
Don’t have your portfolio page set as the home page of your browser. Make a date with yourself on the 1st of the month to log in and see how you’re doing, and commit to not doing so in between times – it’s pointless.
5 – Paying too much in fees and expenses
Regular listeners know that paying excessive fees for your portfolio is a sure way to hamstring your investing success. Every pound spent on fund fees, platform fess, and adviser fees is a pound which is not working towards your future. Imagine that pound compounding over time and the impact of fees can be enormous.
With the advent of the Retail Distribution Review and with it, the abolition of commission, investors are now more aware of fees than they have ever been, and this is a good thing. Commission was a smoke-and-mirrors system, set up to serve the industry and not the client. So many fees were wrapped up in commission you wouldn’t believe.
A typical investor with an adviser may be paying:
- Fund charges – look for the TER, not the AMC
- Platform charges
- Adviser charges
This can easily be over 2% if you’re actively investing, and I’ve seen portfolios with charges over 3% per year. Add in inflation at 3% and you portfolio has to generate 6% a year just to stand still in real terms.
How to avoid this mistake: Take care not to be the person who knows the cost of everything, but the value of nothing. I’ve yet to meet any client who minds paying my fees because I always offer value. In fact, when producing my initial report for clients, which costs anything between £600 and £1000 plus VAT, I tell them that if they don’t think it’s worth it when they get it, they don’t have to pay me. I’ve never yet had anyone take me up on that!
But do question what you’re getting for your fees. Demand service from your adviser and your platform, if you have them. Look for ways to reduce the fees you are paying. Keep trading fees to a minimum if you’re a self directed investor.
6 – Thinking you know what you’re doing
As an adviser, there’s nothing worse than a client who thinks they know what they are doing with investments. Please understand me – I have barely any more idea than my clients do, and some of them would do a better job than me every time. But I’m a financial planner: I don’t manage investments, I bring in the professionals to do it.
The danger is that a few good decisions can lead you to think that you are the special one, and that the markets bend to your will every time. We all know that this is a nonsense. Investing is a science, not an art, and you have to study to be a scientist. You also have to have a good grasp of history and economic cycles – something our present government team at the Treasury is sorely lacking. Arrogance is dangerous – as the old saying goes: pride comes before a fall. Thinking you’re all that can lull you into a false sense of security and cause you to make daft decisions like taking too much risk.
How to avoid this mistake: Understand that the market is much bigger than you are and that any success you have had is probably as much down to chance as it is to skill on your part. Work hard to improve your knowledge and understanding of how investments work, for sure, but be satisfied that Murphy’s Law is very much at play in markets as it is in any other area of life.
Using a passive investing strategy can help with this. The clue is in the name, see. By choosing markets and tracking them, rather than identifying managers, you are letting the markets do their thing, which means you can’t really take any credit!
7 – Letting the tax tail wag the investment dog
Different people have different views on tax. Some people never really give it a moment’s thought, while others lie awake at night trying to think of way to prevent the Chancellor getting his manicured hands on any more of their money. None of us want to pay more tax than is necessary, and a good financial planner will have an array of legitimate tax planning tool sat their disposal.
As an aside, I reckon if you’re driving on the roads and using the hospitals you should pay your share of the tax burden. But tax allowances are there and should be fully used.
The problem comes when people with large tax problems start investing in such a way as to save tax, when they would never invest that way otherwise.
Many of the tax breaks offered by the government are incentives to invest in smaller companies. Enterprise Investment Schemes and Venture Capital Trusts both offer major tax advantages to the wealthy investor but underneath can be very risky investments. Should an otherwise cautious investor use these vehicles just to save tax?
How to avoid this mistake: Tax planning should form part of your general financial planning. Most competent financial planners have enough of a grasp on tax matters that they can deal with the majority of tax situations. If not, they will be able to work with your accountant to identify the best planning angle for you.
In short, tax should be planned in to your finances from the start, so that you are not pressured into fixing your tax problem by investing in a way which might make you feel uncomfortable. At the very least, the implication sod any tax planning investment vehicle should be fully explained to you by your adviser.
8 – Coming over all emotional
Closely related to mistake number 6, making financial decisions on an emotional basis is a classic mistake I see made all too often. While money itself is an entirely passive force, its effect on our wellbeing and emotions is massive and it is hard, if not impossible to shut off this emotional response entirely.
But try you must, because decisions made in the heat of the moment are rarely the correct ones. We need to differentiate emotional decisions like withdrawing funds to help out a family member in distress – that can be a good thing – from emotional decisions made about money itself.
How to avoid this mistake: The key to nailing this one is to understand that money is the enabler of your heart’s desires, a means to an end, and not an end in itself. You should try to channel your emotional responses towards the important things like your plans (see below) rather than the money itself. Towards the destination, rather than the car carrying you there.
If you feel like you’re going to fall foul of this one, try to find the presence of mind to take a deep breath, and sleep on your decision. If you’re in a relationship, decide between you that unless both parties agree, no decision is made.
9 – Not having a plan
I’ve saved the granddaddy till last. If you can prevent yourself from making this one, you’ll go a long way to potting yourself from the others.
Investing for its own sake, taking out life insurance because you feel like you should, building up a random assortment of plans and policy over time – these are all symptoms of not having a plan. Very few people in this country have a coherent financial plan. Advice has always traditionally been product-led, and the advisers were more concerned in finding ‘gaps’ in your financial policy list than in finding out what your eventual goal might be.
Making this mistake will lead to an incoherent financial life, with plans and policies that cost more than they should, and an investment portfolio with no strategy. If you don’t know where you’re going, you’ll never get there, right? Decisions will be made on the basis of short term thinking – always a bad idea.
How to avoid this mistake: Having a plan is all about having a road to run on, and a map to guide the way. The road and the map will change as life and legislation get in the way, but right now, it will inform your immediate decisions concerning your money. With the big picture in mind, small things become irrelevant. All decisions are made in the light of that big picture, and the immediate circumstances shrink in importance compared with the greater scheme.
See a certified financial planner – see session 38 – and get some planning done. It’ll be money well spent and will provide the necessary framework for all future financial decisions. If you’re determined to go it alone, then spend some time thinking about your desired future and work back from there. I’m planning a multi-part series here on how to do your own financial planning, which should be fun, so watch this space for that. But the best advice is always to get professional help in your financial planning. Chances are, the fees will be recouped many times over the course of your life.
So there we have nine mistakes that too many people are making:
- Trying to time the market
- Insufficient Diversification
- Switching too often
- Watching the portfolio too closely
- Paying too much in fees and expenses
- Thinking you know what you are doing
- Letting the tax tail wag the investment dog
- Coming over all emotional, and
- Not having a plan
There are probably a hundred more. Some of my adviser colleagues on Twitter put forward some great suggestions. I wonder, have you made any mistakes that you would like to share with the community? If so, let us know in the comments below.
Philip asked me a question a couple of weeks ago about the Help to Buy scheme. Specifically, he wanted to know the pros and cons of the scheme.
The Help to Buy scheme was designed to help people buy new houses, which give people a foot onto the housing ladder, and help shift new houses, boosting the homebuilders, which will in turn boost the economy. I’ll give you a link with more information in a minute, but here are the main pros and cons:
- You get help to buy your home
- You get to borrow interest free for the first five years (you’ll still need to make mortgage payments though)
- Even after the five years are up, it looks like the interest rates will be very competitive
- Having a bigger deposit, part-funded by the Help to Buy scheme means you can borrow less
- Borrowing less as a percentage of the value of the house means your interest rates from the bank will probably be better
- Your loan will become more and more expensive, from year 7 onwards the rate charged goes up with RPI inflation plus 1% so the rate is going up each year after that
- The loan is based on a percentage of the value of the property, so if you sell the house or pay off the loan it could be significantly higher than the amount you borrowed if house prices have increased
- You can only buy new-build properties
- Only certain mortgage companies will lend to borrowers on the Help to Buy scheme
- The government could move the goalposts and change the terms of the loan in the future
- You could end up in negative equity, that is owing more than your house is worth. Some say that Help to Buy is fuelling a house price bubble, and when that bubble inevitably bursts, you could end up sitting in a house worth less than you paid for it.
So there is much to recommend Help to Buy and quite a few negatives too. Seek advice from a competent mortgage adviser before diving in.
There is a good summary of the scheme on Money.co.uk here: http://www.money.co.uk/article/1009888-help-to-buy-scheme-the-pros-and-cons.htm
…and the Help to Buy website is here: http://www.helptobuy.org.uk/
This week’s reviews
No reviews this week guys, sniff. No. It’s OK. I’m fine…
Seriously, if you like what you hear on this podcast, the best way you can thank me is to please leave a rating or review on iTunes by going to meaningfulmoney.tv/iTunes. This helps others to hear about the show and to subscribe, because it keeps me near the top of the rankings.
Large Cap/Small Cap: You hear this phrase used when talking about investing in shares. A company’s market capitalisation, or market cap, is the sum total value of all its shares added together. A company with a massive market cap would be a large cap company. There are differences of opinion about what constitutes a large cap company – most sources I’ve looked at say $10 Billion or more.
By extension, a small cap company is a company with a small market capitalisation – a lower value company.
Large cap and small cap company shares often behave very differently from one another – holding both is a good idea for diversification.
This week’s weight update. I have dropped six pounds, down to 17stone 11lbs – a good start. Only 53 lbs to go!
Next Session Announcement
Next time we'll be talking about how to prepare for your tax return. With the Janauary 31st deadline just round the corner, this is a hot topic. If you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/feedback
That's it for this session of the MM podcast, I hope it was helpful. Did I miss anything? Do you have any questions? If so, please leave comments or questions below.
I hope you enjoyed this session. Thanks for listening – I'll talk to you next time