Recognizing How to Avoid Missteps is Often the Most Important Part of Creating a Successful Investment Program.
By repeatedly committing one or several common investment mistakes, individual investors often prove to be their own worst enemy.
Unfortunately, even seemingly simple missteps can, over time, have a dramatic impact on overall returns. Recently, CFA Institute, which administers the prestigious Chartered Financial Analyst(r) (CFA(r)) program worldwide, asked selected members to share their perspectives on some of the most common and costly mistakes they witness individual investors make.
Among the most common mistakes:
1) No investment strategy. From the outset, every investor should form an investment strategy that serves as a framework to guide future decisions. A well-planned strategy takes into account several important factors including time horizon, tolerance for risk, amount of investable assets and planned future contributions. "At the outset, individuals should have a clear sense of what they want to accomplish and the amount of volatility they're willing to bear," remarked Jeanie Wyatt, CFA, CEO of San Antonio-based South Texas Money Management.
2) Investing in individual stocks instead of in a diversified portfolio of securities. Investing in an individual stock increases risk versus investing in an already-diversified mutual fund or index fund.
Investors should maintain a broadly diversified portfolio incorporating different asset classes and investment styles. Failing to diversify leaves individuals vulnerable to fluctuations in a particular security or sector. Also, don't confuse mutual fund diversification with portfolio diversification, said Brian Breidenbach, CFA, CPA, Managing Principal of Breidenbach Capital Consulting, LLC in Louisville, KY. You may own multiple funds but find, on closer examination, that they are invested in similar industries and even the same individual securities.
However, remember that it is also possible to over-diversify and own too many investment products -- particularly if an investor has a modest portfolio -- generating higher overall fees relative to the portfolio size, commented Wyatt. The best course of action is to seek a delicate balance between the two. Often, this can best be done with the advice of a professional or trusted advisor.
3) Investing in stocks instead of in companies. Investing is not gambling and shouldn't be treated as a hit-or-miss proposition. Investing is assuming a reasonable amount of risk to help finance enterprises you believe have positive long-term growth potential. Analyze the fundamentals of the company and industry, not day-to-day shifts in stock price. "Buying a particular stock purely on the basis of market momentum or because you like a company's product or service is a sure-fire way to lose money," commented Bob Bilkie, CFA, president of Southfield, MI-based Sigma Investment Counselors. In addition, examine a company's corporate governance profile to make sure it has basic corporate governance protections. It may help you avoid a future problem.
4) Buying High. The fundamental principle of investing is buy low and sell high. So why do so many investors get that backwards? The main reason is "performance chasing," notes Beth Hamilton-Keen, CFA, of TAL Private Management in Calgary, Alberta. "Too many people invest in the asset class or asset type that did well last year or for the last couple of years, assuming that because it seems to have done well in the past it should do well in the future. That is absolutely a false assumption." Cathy Tuckwell, CFA, of Scotia Cassels Investment Counsel in Toronto, Ontario agrees. "The classic buy-high/sell-low investor profile is someone who has a long-term investment strategy, but doesn't have the tenacity to stick with it," she said. "They throw their strategy out the window in response to short-term blips in the market and invest tactically instead of strategically.
Others at risk for "buying high" are those who follow investment fads, buying the "popular" stocks of the day. Typically, these investments become fashionable for brief periods, leading many to invest at the height of a cycle or trend -- just in time to ride it downward.
Always look critically at the prospects for future performance of a given investment, not just past performance, Tuckwell emphasized.
5) Selling Low. The flip side of the buy-high-sell-low mistake can be just as costly. "Too many investors are reluctant to sell a stock until they recoup their losses," according to Rajiv Vyas, CFA, business reporter at the Detroit Free Press. "Their ego refuses to acknowledge a mistake of buying an investment at a high price." Smart investors realize that may never happen and cut their losses. Keep in mind not every investment will increase in value and that even professional investors have difficulty beating the S&P 500 index in a given year. Always have a stop-loss order on a stock. It's far better to take the loss and redeploy the assets toward a more promising investment.
By repeatedly committing one or several common investment mistakes, individual investors often prove to be their own worst enemy.
Unfortunately, even seemingly simple missteps can, over time, have a dramatic impact on overall returns. Recently, CFA Institute, which administers the prestigious Chartered Financial Analyst(r) (CFA(r)) program worldwide, asked selected members to share their perspectives on some of the most common and costly mistakes they witness individual investors make.
Among the most common mistakes:
1) No investment strategy. From the outset, every investor should form an investment strategy that serves as a framework to guide future decisions. A well-planned strategy takes into account several important factors including time horizon, tolerance for risk, amount of investable assets and planned future contributions. "At the outset, individuals should have a clear sense of what they want to accomplish and the amount of volatility they're willing to bear," remarked Jeanie Wyatt, CFA, CEO of San Antonio-based South Texas Money Management.
2) Investing in individual stocks instead of in a diversified portfolio of securities. Investing in an individual stock increases risk versus investing in an already-diversified mutual fund or index fund.
Investors should maintain a broadly diversified portfolio incorporating different asset classes and investment styles. Failing to diversify leaves individuals vulnerable to fluctuations in a particular security or sector. Also, don't confuse mutual fund diversification with portfolio diversification, said Brian Breidenbach, CFA, CPA, Managing Principal of Breidenbach Capital Consulting, LLC in Louisville, KY. You may own multiple funds but find, on closer examination, that they are invested in similar industries and even the same individual securities.
However, remember that it is also possible to over-diversify and own too many investment products -- particularly if an investor has a modest portfolio -- generating higher overall fees relative to the portfolio size, commented Wyatt. The best course of action is to seek a delicate balance between the two. Often, this can best be done with the advice of a professional or trusted advisor.
3) Investing in stocks instead of in companies. Investing is not gambling and shouldn't be treated as a hit-or-miss proposition. Investing is assuming a reasonable amount of risk to help finance enterprises you believe have positive long-term growth potential. Analyze the fundamentals of the company and industry, not day-to-day shifts in stock price. "Buying a particular stock purely on the basis of market momentum or because you like a company's product or service is a sure-fire way to lose money," commented Bob Bilkie, CFA, president of Southfield, MI-based Sigma Investment Counselors. In addition, examine a company's corporate governance profile to make sure it has basic corporate governance protections. It may help you avoid a future problem.
4) Buying High. The fundamental principle of investing is buy low and sell high. So why do so many investors get that backwards? The main reason is "performance chasing," notes Beth Hamilton-Keen, CFA, of TAL Private Management in Calgary, Alberta. "Too many people invest in the asset class or asset type that did well last year or for the last couple of years, assuming that because it seems to have done well in the past it should do well in the future. That is absolutely a false assumption." Cathy Tuckwell, CFA, of Scotia Cassels Investment Counsel in Toronto, Ontario agrees. "The classic buy-high/sell-low investor profile is someone who has a long-term investment strategy, but doesn't have the tenacity to stick with it," she said. "They throw their strategy out the window in response to short-term blips in the market and invest tactically instead of strategically.
Others at risk for "buying high" are those who follow investment fads, buying the "popular" stocks of the day. Typically, these investments become fashionable for brief periods, leading many to invest at the height of a cycle or trend -- just in time to ride it downward.
Always look critically at the prospects for future performance of a given investment, not just past performance, Tuckwell emphasized.
5) Selling Low. The flip side of the buy-high-sell-low mistake can be just as costly. "Too many investors are reluctant to sell a stock until they recoup their losses," according to Rajiv Vyas, CFA, business reporter at the Detroit Free Press. "Their ego refuses to acknowledge a mistake of buying an investment at a high price." Smart investors realize that may never happen and cut their losses. Keep in mind not every investment will increase in value and that even professional investors have difficulty beating the S&P 500 index in a given year. Always have a stop-loss order on a stock. It's far better to take the loss and redeploy the assets toward a more promising investment.