How to Avoid the 5 Biggest Mistakes Investors Make

Give your portfolio the best chance for success by avoiding these errors

Photo by NeONBRAND on Unsplash

I’ve worked with financial planning clients and their investments for close to 15 years, across 2 countries. There have been many clients over this time who have been managing their portfolios themselves prior to coming to see me. Some of them have been doing a fairly good job. What’s been really interesting to me is that for those who aren’t doing so great, the mistakes they are making are often very similar.

One of the benefits of being a Financial Planner is being able to see hundreds of different portfolios in action over the years. I’ve seen how they perform during good times, and I’ve seen how they’ve performed during bad times. Whilst we can’t only look at history to make our future investment decisions, it can provide some valuable lessons if we are prepared to pay attention.

I’m going to explain to you what I think are the 5 biggest, most common mistakes that investors make when they are running their own portfolios, and I’m going to show you how you can avoid making them yourself.

1. All Shares

This one usually comes up after a period when stock markets have been volatile. A prospective new client will be sitting down with a Financial Planner because their portfolio has had a bad year or 2, and they want to see whether they can be doing anything to limit this up and down rollercoaster ride.

These conversations often begin with the clients explaining that they are very cautious investors and they don’t like to take a lot of risks with their money. Because of this, their portfolio consists of only the most blue chip shares.

I’m sorry, what?

Yes, it is incredibly common for DIY investors to be invested 100% into shares, regardless of their attitude to risk or stage of life. This might be appropriate for an investor in their 30’s or 40’s who is saving for retirement, but if you are planning on accessing any of your funds in the short term, it’s a recipe for disaster.

During the peak of the Coronavirus pandemic, the UK stock market fell 34%. Regardless of whether your shares are “blue chip” or not, when markets fall that heavily your shares are going with it. You can imagine that if you relying on this portfolio for your retirement income or to use as a deposit for your first house, this isn’t an ideal situation.

As an investor you need to have a really good understanding of volatility, risk and how much you are prepared to take. I talk more about risk in this article.

One way to gain an understanding of the risk you are willing to take is to look at some of the worst historic performance figures. If you are going to be investing solely in the UK market, consider that recent example of -34%. How would you feel if that happened to your portfolio?

The best way to reduce risk in a portfolio is to increase diversification. Rather than investing all of your money into one stock market, it should be spread across various different asset classes and different countries. Other asset classes to consider include property, fixed interest and alternative investment like infrastructure.

Increasing your diversification is the first step to decreasing the volatility in your portfolio and minimising your risk.

2. Trading too much

There are a lot of investors who fancy themselves as day traders. Buying and selling shares and investments on a regular basis can significantly increase your costs, whilst at the same time creating a situation where you may miss out on significant gains.

A typical dealing charge will cost you around £10. Remember that to sell 1 holding and buy another is 2 trades so each investment switch is going to cost you £20. If you do that even just twice per week, you’ve racked up over £2,000 in dealing charges over the course of a year. It doesn’t take a genius to realise how much this could potentially eat into your return.

In addition, time in between these trades means you will be out of the market a lot. This is the time between each sale and purchase where your money is ‘in transit’ and not invested.

Bank of America recently released statistics that showed if you had invested in the S&P 500 in the 1930’s and left it, the total return would have been 16,166%. If, however, you had missed the 10 best days in each decade, that return drops to just 17%!

Days out of the market are a potential killer to investment returns.

Pretty simple this one. Don’t shuffle money too much! Setup up your investment portfolio with a long term view. Review on a regular basis to make sure the investment mix is still right for you, but don’t trade needlessly. Only make investment moves where you have a real, defined reason for doing so.

As the great investor Warren Buffet says,

If you don’t feel comfortable owning a stock for 10 years, don’t own it for 10 minutes.

The same can be said for most investments, not just stocks.

3. Panic selling

The old stock market adage goes that you should buy low and sell high. Makes total sense. Talk to people at a barbecue and everyone will agree that this is the sensible way that everyone should manage their investments.

The fact is, it’s not what people actually do. When stock markets are reaching all-time highs, new money going into investments is almost always also at its highest levels. When markets start to crash, vast amounts of money come pouring out of investments and into safe havens like cash.

This is the worst possible reaction to market corrections. Doing this means investors are actually doing the opposite of the well-trodden advice. They are buying high and selling low!

Particularly in the wake of the 2008 Global Financial Crisis, I’ve seen many investors who panicked, sold everything and have been sitting in cash ever since. The problem is that once you are out of the market through fear, it can be incredibly hard to know when the right time is to go back in. Unfortunately, many investors finally feel comfortable to get back in just as the market is peaking again and ready for another correction!

If your portfolio properly matches your attitude to risk, you should feel comfortable with anything that comes your way. This is why getting things right initially is the best way to avoid panicking and selling when you shouldn’t.

Even if you do this, investing can sometimes be scary. It’s important to remember why you’re investing, what your time frame is and also what you are actually investing in. Don’t panic, breathe and try to look at things in a logical way.

In my opinion, this area alone is a key benefit of having a Financial Planner and professional investment managers in your corner. You don’t pay them for when everything is rosy and perfect, you pay them to get you through these difficult times.

4. Stock tips

If I had a penny for every time John’s mate’s sister’s hairdresser had the next hot stock tip that would make me millions, I’d have a few pounds by now. I’ve had clients pass on stock tips to me hundreds of times. Often they want to take some of their investment portfolio and invest into this new tech company or mining stock or some other garage outfit that is apparently going to be the next Facebook.

It never pans out.

Now don’t get me wrong, I don’t have a problem with having a punt on a startup or gambling on a mining company. The important thing to remember is that is exactly what it is. Gambling. When investing into companies in the very early stages, it is vital that you understand that the overwhelming likelihood is that you will never see that money again.

This is the case even for the billionaire professional Venture Capital (VC) firms. Success rates for startup businesses seeking VC funding can be as low as 0.05%. If they can’t successfully do it, I’m not sure how much I would count on tips from the mechanic.

By all means, have a gamble on a penny stock if you want to. It’s not worse than a trip to the casino, spending big on a night out or buying a lottery ticket. But do not make these sorts of bets the cornerstone of your wealth creation strategy.

It can be fun to get swept up in the story of a new company and imagine the riches that it might bring you. Just make sure you have a stable, well-diversified investment portfolio to make up the bulk of your financial plan.

5. Home bias

This one makes a lot of sense. When you’re walking down the street you see supermarkets, clothing stores and service stations. When you go to invest, it’s understandable that these brands that you see every day seem like better investments. If you live in the UK, many of the companies listed in the US stock markets will be unknown to you, and that can making investing there seem more risky. In reality, that’s not really the case.

Putting too much focus on the stock market of your home country means you are limiting your level of diversification and access to certain sectors. This is really important because different countries will often be going through different stages of the investment cycle at different times. When your shares in one country are down, others may be up. This all helps to smooth out the returns you receive.

As well as this, there are certain sectors that are simply not well developed in certain countries. The technology sector is a great example. If you invested only in UK shares, you will be missing out one of the largest sectors in the world’s stock markets.

When talking about diversification, it’s important that an investor doesn’t just focus on having different types of assets within their portfolio. Just as important is having a spread of investments within each asset classe. Shares in multiple different countries, bonds from different governments and companies and property and infrastructure spread globally.

It’s a big wide world out there and it’s really important that your investment portfolio reflects that.

There is no perfect way to invest. Sometimes things will go well, sometimes things will go badly. By avoiding these 5 common mistakes, you’ll put yourself in the best possible position to get it right more than you get it wrong.

This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.

Disability Dad. Expat. Financial Planner. (Very) Amateur Filmmaker.

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