Three Common Mistakes Investors Make:
Michael Johnson, a legendary sprinter, once remarked that the only person who could beat him was himself, implying that his greatest adversary lay within. This analogy holds true for investors as well—the most formidable obstacles to your investment success often come from your own actions.
As Wealth Managers at Parity Wealth Managers, we frequently observe that clients who manage their own portfolios fall into similar pitfalls. Here are the top three mistakes they make:
1.Trying to Time the Market:
Attempting to time the market is a futile endeavour. Many investors fall into the trap of buying high and selling low, driven by emotional responses like greed and fear. It’s these very emotions that disrupt the ability to capture optimal investment performance.
This behaviour often leads to investors exiting their positions during a downturn, thereby missing out on subsequent market recoveries. Consider the S&P 500 as an illustrative case: the majority of its best and worst days often cluster around periods of market decline and heightened volatility. For instance, within a month of a 20% drop in 2020, the S&P 500 rebounded by 12.50%, and after a year, it surged by 59%. Missing just a few of these pivotal days can have a significant and lasting impact on the long-term growth of your portfolio.
Over a 20-year span from 2002 to 2021, missing just five of the best trading days could decrease your annualised returns from 9.50% to 7%. Missing ten of these crucial trading days would lower the annualised return to 5.31% and missing 20 days drops it to 2.62%. Being out of the market during 40 of the most significant trading days—approximately two months—over that same period would result in a decrease of 1.50%.
Accurately timing the market to capture the best 5, 10, 20, or any specific number of beneficial days across two decades is an exceedingly challenging task. This difficulty highlights the futility of market timing as a strategy for individual investors.
|
After a 20% decline |
1 month | 1 Year |
|
2020 |
12,50% |
59% |
| 2009 | 10,70% |
47,30% |
Peter Lynch aptly noted, “Far more money has been lost by investors preparing for corrections, or trying to anticipate them, than in corrections themselves.”
Prevention Strategy:
Align your investment strategy with your risk profile. Employ strategies like dollar-cost averaging, which mitigates timing errors by spreading investments over regular intervals, thus averaging your market entry points.
2.Panic Selling:
The psychological impact of losses is typically twice as potent as the joy of gains—a principle known as loss aversion bias. It’s not uncommon for investors to sell off or rebalance their investments when they see them depreciating, particularly during market downturns. However, it’s crucial to remember that a loss is not realised until you sell your holdings.
Prevention Strategy:
Accept that market volatility is part and parcel of investing. Educate yourself to overlook short-term fluctuations and avoid overanalysing your investment statements. Maintaining a long-term perspective can help mitigate the impulse to sell during downturns.
3.Investing in Fads:
Investments are often subject to fads and cycles, leading to inflated valuations unsupported by fundamental analysis. Many investors buy into trends simply because they seem poised to rise in value without a solid rationale. This does not imply that you should overlook sectors and companies that are experiencing growth or have shown strong performance. Instead, it’s crucial to base your investment decisions on robust analysis and informed advice.
Prevention Strategy:
The key lies in selecting the right holdings from the outset and holding onto them over extended periods. This straightforward approach is often more challenging than it appears but is crucial in avoiding the pitfalls of trend-based investing. As Warrant Buffet noted in his shareholder letter in 1999, “Over time, of course, the performance of the stock must roughly match the performance of the business.”
Conclusion:
Investors can significantly enhance their performance by steering clear of these common errors. By adopting a disciplined, well-informed investment strategy, you can protect your portfolio from the pitfalls of emotion-driven decisions and market misinformation.
At Parity Wealth Managers, we practice long-term investment strategies. For more insights, visit us at: www.paritywm.com
