Common investment mistakes and how to avoid them
ARTICLE SOURCE: AWARE | AUTHOR: JAMES WILLIAMSON
This article covers some of the basics to help you avoid some common traps and pitfalls when it comes to investing your super. By avoiding them, you can get on track to building your wealth over the long term.
Whether you’re a professional, experienced or novice investor, growing your wealth takes practice, patience, commitment, luck, and recognition that you will make mistakes before you get it right. Even legendary investors like Warren Buffet get it wrong sometimes, but it’s those mistakes that have made Buffet a better investor.
If you’re careful and learn about investment pitfalls and how to avoid them, you can have a better investment journey to build your wealth over the long term. Before we do this, let’s look at why timing the market is hard and why even seasoned investment professionals don’t do it.
Timing the market is hard
Professional, successful investors like Buffet don’t time the market- for good reasons. There are plenty of theories about picking the top of the market when selling or the bottom of the market when buying, but none has been widely accepted as best practice. That’s because investing is by nature a long-term proposition that’s meant to be as exciting as watching paint dry (though it can be much more lucrative). Some investors speculate, but that’s not the same thing as investing.
Investing in ‘growth’ asset classes like shares or property is a five-to -seven-year proposition at least. That’s how long it takes to ride out the peaks and troughs to get the best possible long-run return. Let’s look at an example to illustrate this point:
Example – Australian shares (ASX 200)
The 12 months to 31 March 2020 saw COVID hit the world and the ASX 200 shed almost a quarter of its value over that time. This period included two bouts of volatility. The first was between August and September 2019. The second was the massive 27% drop in February-March of 2020. Some investors reacted by pulling out of shares in panic for the safety of cash. While this is an understandable emotion, it was the wrong investment decision. Why? Because when viewed with a long-term lens, these share losses were just ‘speed humps’ on the road to strong returns and genuine wealth creation. Patient investors understand this, and their super has grown as a result. The numbers tell the story:
From April 2020 to December 2021 the ASX 200 recouped all its COVID losses and then some, rising a total of 25.3%.
Over the seven years to December 2021 the ASX 200 returned a total of 40%, a great result given the savage COVID-driven falls of early 2020.
Over 10 years to December 2021 the ASX 200 returned a total of 118%.
Over 50 years to December 2021 the ASX 200 returned around 9.5% per annum. This is an astonishing result because it includes five huge dips - the long bear market of 1973-74, the Black Monday crash of 1987, the 1998 Tech Wreck, the Global Financial Crisis of 2008-09, and the COVID plunge of early 2020.
>> The lesson here is that investing over a short time frame or trying to time the market may not lead to the best investment outcome. History has proven that investing over the long term will help you ride out the inevitable market fluctuations and let compounding (accumulated returns) do its job for you. There are things you can do to avoid the investment pitfalls.
Things you can do to avoid the investment pitfalls
Don’t get emotional but do stay involved
The best investors keep calm and level-headed even when the market is melting. They stay involved in their investments, they do not panic, and they look for investment opportunities amid the market ‘noise’ and often panicky news headlines. Fear and greed drive the share market at these times and being hostage to these emotions can lead to failure for investors who jump into and out of stocks rather than investing in a skillful, considered manner over the long term.
“The best investors keep calm and level-headed even when the market is melting.”
Understand your risk tolerance and spread your risk
Investors need to understand their risk tolerance. This is about truthfully acknowledging how much risk you can take and when to take it. Diversification - spreading your investments across different asset classes and investments - is one of the best ways to understand, manage, and reduce your investment risk. Investing regularly and for the long term can also help mitigate risk. That said, aside from cash deposits, no investment is risk-free.
Understanding what you’re investing in
It seems obvious but understanding what you’re investing in is crucial. Do you know what the company you’re buying shares in does? Do you know its cash flow, its competitors and its products? Do you understand the true yield of a prospective investment property? After all, it’s your money, so it pays to do our homework and understand the basics, even when investing in your super or in an index fund (a portfolio whose investments essentially match an index like the ASX 200). When it comes to your super investments, you may want to consider how comfortable you are with how your fund invests, whether it takes too much or not enough risk, what your fund’s long-term performance track record is compared to peers, and if it’s well-rated by independent research agencies.
Learn, be humble
Making mistakes in investing is a normal part of the process of becoming a more experienced, better investor. Like Buffet, we all have wins and losses. The problem is not learning from your mistakes despite having the facts, evidence and learning lessons before you. The good news is that simply by being aware, humble, patient, positive and long-term-focused, you’re already well down the track to building your wealth for a better retirement.
