Common mistakes in investing costs money. Ultimately, they reduce the value of assets. We have come across people over the years who, on their own initiative, due to not be able to keep their cool during market stress switched their assets into cash waiting for the markets to calm down. We have also come across people who although they moved their assets into cash (during the 2008 credit crisis) after that they forgot to switch back into the markets missing out substantial gains.
It is very important to know and remember at all times what is you are investing for?
A well thought out financial plan answers this question since it has already taken into account lifetime objectives, time horizon and risk tolerance. Market fluctuations are part of the journey.
Investors Often Misunderstand Risk & Return. Although risk and return are two of the most commonly used terms in an investor's vocabulary, their definitions can often be unclear. History has shown that investors have not been taking the idea of risk as seriously as they should, and they have been overexposing themselves to equities. Moreover, they have not learned from past mistakes or mistakes of other people.
The following will define risk and return both in terms of best practices and in real world application.
Best Practice: The asset's expected annual rate of return on investment.
Common use: Often, a financial adviser/investor using the term "return" will be referring exclusively to the price history of an asset, rather than its expected rate of return in the future. Historical price is at best a dangerous proxy for predicting the future.
Best Practice: In simple terms, it is the variability of the expected return (either up or down) over your investment period. However, a given level of variability (risk) today or in the past may not be representative of the future. This has been the case in 2008 and during the period 2000-2003 where risk in the worlds markets had increased.
Common use: Often, investors understand the term "risk" as knowing that investments can go down or lose money. This generalisation of risk, so prominent in the industry, requires several assumptions.
An investor must assume that the following risk attributes will be present in the future in the same or different proportions and magnitudes:
Investment Risk, Sequence of Return Risk Market Risk, Credit Risk, Business Risk, Currency Risk, Political Risk, Country Risk, Interest Rate Risk, Liquidity Risk, Counter-party Risk, Legal Risk and so on. There are other types or risk as well.
However, the concept of risk is something with deal with every day, in every aspect of our lives. Crossing the road, driving a car and so on, but that does not mean there is anything wrong with them. Through this article, it is our aim to help you recognise common investment mistakes and provide insight on how to avoid them.
Here are some reminders to help keep your cool:
That is why, it is vital we create an environment for investing that is detached from emotion, one that relies on personalised advice and data and impartial analysis to make the right decisions for your financial future.
When doing nothing is best
From time to time, stock markets go through periods of uncertainty. This could be down to some poor economic news or perhaps due to a political crisis, for example, the 1970’s oil crisis, the 2000-2003 internet bubble and the 2008 credit crisis and so on.
The sharp falls that can be experienced at such times are understandably unsettling for investors. They can even tempt some to change their long-term plan by selling their investments. However, stock market volatility does tend to be short lived. Therefore, most experts agree that investors are probably better off sitting tight through these unnerving periods.
Those who sell or delay making new investments when stock markets become uncertain are actually employing a strategy known as 'market timing'. The intention is often to invest once stock markets have calmed down or to buy when stock markets have gone even lower. This can be a very dangerous strategy.
Sharp falls in stock markets tend to be concentrated in short periods. Similarly, the biggest gains are often clustered together. It is also quite common for a large gain to follow a big fall (or vice versa). Accordingly, an investor who tries to anticipate when the best time is to invest runs a very high risk of missing the best gains. This can have a big impact on their long-term return.
To help illustrate this, Fidelity Investments have analysed the average annual return from the UK stock market over the last 15 years. As the chart shows, missing just the ten best days over this period would have cut your annual return substantially. Timing the stock market is extremely difficult, the best policy is usually to stay fully invested over the long term.
FTSE All Share Index: Effect of missing best days
Source: Datastream from 31.12.04 to 31.12.19, annualised return | Returns based on the performance of the FTSE All-Share, with initial lump sum investment of £1,000 on a bid to bid basis with net income reinvested
FTSE All Share Index
How the index has performed over the last five years
Source: Datastream from 31.12.14 to 31.12.19, on bid-bid basis with net income | Please note that past performance is not a reliable indicator of future returns. The value of investments can go down as well as up, so you may get back less than you invest.
The value of advice
This information is not a personal recommendation for any particular investment. When making decisions about investing, we spend considerable amount of time teaching our clients the important principles of investing before we design their asset allocation and investment policy. We work very closely with our clients so we understand their needs and, then offer tailor-based advice to help achieve their long-term goals.