We are often overwhelmed with thoughts and strategies about how to invest wisely, but there is also considerable value in knowing what to avoid when investing.
Here we highlight a few of the traps that even sophisticated investors fall into. These habits develop for numerous reasons – because we are time poor, because we typically have strong faith in our abilities and because we are often comfortable with the way things are.
Trying to time the market
Professional and private investors alike often try to anticipate the movements of markets and to swiftly adapt to changing circumstances. This tendency can be due to overconfidence or simply the fact that we want to protect our investments – a natural instinct.
The reality, however, is that trying to time the market to gain an advantage is almost impossible to achieve consistently. In fact, over a 30-year period (from 1/1/1987 to 30/12/2016) average investor returns in US equity funds were less than half the S&P 500 index per annum (3.98% for the investor vs 10.16% for the market)¹.
This article examines the consequences for investors who have repeatedly chosen the wrong points to trade in and out of the market, and who have invested in active funds that typically cost more and underperform the market over many years.
Paying too much in fees
Over time it’s easy to enjoy a comfortable familiarity with those who look after our money. A wealth manager may call us once a year with an update, enquire about the family and possess the reassuring presence for which they are renowned. We must make sure we are getting the right value from such relationships: high fees cannot be justified solely based on past performance when the largest contributor to portfolio returns is simply driven by what the market provides – as discussed in this article.
Even without the supportive-but-costly embrace of a traditional wealth manager, investors can still pay over the odds in fees for many years. Inertia can prevent us from doing the right thing with our money even when we suspect we are losing out – and often it is only when investors realise the remarkable impact of lower fees are they prompted to do something about it.
Source: Numis Securities, Citywire, Netwealth. Based on an illustrative return of 5.3%, gross of fees, and assuming average all-in charges of 1.82% for Traditional Wealth Managers (Numis findings) and 0.7% for Netwealth.
Please note that forward looking models are not a reliable indicator of future performance.
Playing it too safe
Being prudent is one thing, and often recommended when investing – but being too cautious when investing can be quite damaging, as this feature explains.
In a nutshell, the article highlights the dangers of holding too much of our wealth in a bank account or cash ISA. Cash is, of course, essential for everyday expenses and for emergencies like cover for times of unemployment or when we have no income. Yet while holding more cash than we need may seem safe, the dangers of inflation are persistent, and being underinvested can have a dramatic impact on the value of our wealth over the long term.
The sensible answer for many investors is to set aside enough cash for everyday expenses and emergencies and to have a widely diversified portfolio to diminish the risks of one asset class alone.
Thinking we know it all, or know more than enough
Because we don’t always behave rationally by nature, by extension we also have a tendency to behave irrationally with our money. Sometimes this has little obvious effect, but over time – especially with inertia and overconfidence as described above – this behaviour can have a drastic impact on our finances.
This article highlights the common biases which can take hold. And while there is little we can do to prevent their intrusion, being mindful of their consequences can help us to take action to mitigate their effects.
Not making the most of tax wrappers
Putting money away regularly for a future goal makes sense, but it’s best to shelter our investments as much as possible from tax. It’s easy to forget to use our ISA and pension allowances to the full – especially during the end of tax year rush – but making the most of available tax wrappers can significantly impact our wealth as we can see here.
Need help with a successful investment approach?
As we have shown, there are numerous traps that even knowledgeable investors can overlook when investing. A modern wealth manager like Netwealth can help you overcome the many obstacles and be better prepared for the future so please get in touch.
Please remember that when investing your capital is at risk.
1 Source: Dalbar Associates - https://svwealth.com/wp-content/uploads/2018/04/dalbar_study.pdf