Investing is confusing enough as it is – and it’s not helped when many of the ‘rules’ aren’t actually right.
For one thing, following the crowd isn’t always a safe move – and the experts aren’t always right. And staying on top of your investments can actually be a bad thing, while playing it too safe will hold you back.
“Many of the mistakes investors make are based on common sense rules of thumb that turn out to be wrong,” said Shane Oliver, AMP Capital chief economist and one of Australia’s top economists, in a recent note.
“As a result, it’s often wise for investors to turn common sense logic on its head.”
According to Oliver, there are nine rules that you shouldn’t follow when investing:
1. Following the crowd
Oliver cites a famous quote from Warren Buffet: “Be fearful when others are greedy. Be greedy when others are fearful.”
If you, your friends and the media are all investing in the same asset, you must be on the right track – right? “Safety in numbers” is often doomed to failure,” Oliver said.
When just about everyone has bought into an asset, the danger is there’s not many people left to buy when there’s more good news, but lots of people to sell when things go sour. The same goes for when everyone’s sold.
“So, it turns out that the point of maximum opportunity is when the crowd is pessimistic (or fearful) and the point of maximum risk is when the crowd is euphoric (and greedy).”
2. Placing too much stock in past performance
You’ve most likely seen this disclaimer before: “Past performance is not a reliable indicator of future performance.”
Investors often make assumptions to process lots of information – but this often leaves them guided by the expectation that recent poor returns will continue.
“The problem with this is that when it’s combined with the ‘safety in numbers’ mistake, it results in investors getting in at the wrong time (eg, after an asset has already had strong gains) or getting out at the wrong time (eg, when it is bottoming).”
3. Believing 'experts' will show the way
Economists’ and experts’ forecasts can only go so far. “The reality is that no one has a perfect crystal ball. It’s well-known that forecasts as to where the share market, currencies, etc., will be at a particular time have a dismal track record so they need to be treated with care.”
The grander the prediction, the more we need to treat it with skepticism. And if forecasts were right every time, they'd be rich and would have retired by now, Oliver said.
“A lot of money can be lost as a result by those who come late to the party or don’t get out in time.”
4. Believing shares can’t go up in a recession
If the economy is in the pits, investor sentiment will be low too, right? Not exactly.
“The reality is that share markets are forward looking, so when economic data and profits are really weak, the market has already factored it in,” Oliver said.
History shows that the biggest gains are made when news is poor.
“In other words, things are so bad they are actually good for investors. This seemingly perverse logic often trips up many investors.”
5. Refusing to budge from your views
Many people’s investment decisions are driven by fixedly pessimistic views, like ‘there is too much debt’, ‘a house price crash is imminent’.
“This is easy to do as the human brain is wired to focus on the downside more than the upside and so is more easily attracted to doomsayers.
“They could turn out to be right one day, but end up losing a lot of money in the interim,” said Oliver. “Giving too much attention to pessimists doesn’t pay for investors.”
6. Revisiting your investments too often
Oliver has warned extensively about overly obsessing over your investments’ performance.
On any given day, it’s a 50-50 chance share markets are either up or down; but viewed on a monthly basis, markets generate positive returns more than 60 per cent of the time. This increases to over 70 per cent on a calendar year basis.
“Being exposed to this very short term ‘noise’ and the chatter around it can cause investors to freeze up,” said Oliver.
“The trick is to turn down the noise and have patience.”
7. Overcomplicating things
Investing has become more accessible – but at the same time, there’s never been more options on the market or information to process.
“The trouble is that when you overcomplicate your investments, it can mean that you can’t see the wood for the trees,” said Oliver.
“You spend so much time focusing on this stock or ETF versus that stock or ETF ... that you ignore the key driver of your portfolio’s risk and return.
“So avoid clutter, don’t fret the small stuff, keep it simple and don’t invest in things you don’t understand.”
8. Playing it too safe, too early
Keeping money in the bank is low risk, and great for near-term spending and emergency funds – but won’t build you any wealth in the long-term, Oliver noted, especially with interest rates at rock-bottom.
So you’ll find it difficult to fund your retirement if you don’t put enough in ‘growth’ assets early on in your life.
“Despite periodic setbacks [such as world wars, GFC, etc],, shares and other growth assets provide much higher returns over the long term than cash and bonds.”
9. Timing the market
Quoting veteran investor Peter Lynch, who oversaw the best-performing mutual fund in the world, Oliver said: “More money has been lost trying to anticipate and protect from corrections than actually in them.”
In short: trying to time the market, for most people, is “very difficult” – and one of the above eight mistakes tend to kick in, wiping out gains.
“Perhaps the best example of this is a comparison of returns if the investor is fully invested in shares versus missing out on the best days,” said Oliver.
“Of course, if you can avoid the worst days during a given period, you will boost returns – but this is very hard to do, and many investors only get out after the bad returns have occurred, just in time to miss out on some of the best days and so hurt returns.”
If you’re fully invested in Aussie shares from January 1995, you’d see returns of 9.5 per cent every year, according to the economist.
“But if by trying to time the market you miss the 10 best days the return falls to 7.4 per cent p.a. If you miss the 40 best days, it drops to just 3.1 per cent p.a. Hence, it’s time in that matters, not timing.”