Don’t Make these investing beginner mistakes!
The American professor Harold Lewis once said that those who are unwilling to invest in the future haven’t earned one.
If you are an investing beginner, just starting is the most important step. You need to invest now to make sure you are comfortable for the future, especially when it comes to your retirement. Most will agree that it’s a pretty good idea to put aside some of their hard earned for a comfortable future, but even if they’ve taken steps to do that they are often prone to some common investing mistakes.
There are lots of different avenues you can go down to invest for the future. There are also a lot of mistakes that can be made and this fallibility apparently doesn’t diminish, even with literally thousands of books, articles and videos on the subject.
I’ve put together my list of the most common errors for investing beginners that I’ve either made myself and learned the hard way, or I’ve witnessed countless others make on my meandering journey so far.
1. NOT ENOUGH RISK – THE MAIN INVESTING BEGINNER MISTAKE!
This goes first because I’ve had more conversations about this than any other investment topic. It’s such a big subject but, for the risk averse amongst you, I’m going to try and crack it in a few short paragraphs!
What are we referring to when we think of risk? Is a stock market investment higher risk than a bank account for example? Any risk profiling software in the world would say yes, but let’s analyse it…
What would have to happen for you to lose all of your money in a stock market investment? Such an investment could be a holding in one company or an entire index of course. Let’s generalise though and assume you hold an MSCI World Index tracker…
For you to lose all of your money, every single company in that index would have to go out of business at the same time. Some of the biggest companies in the world including tech giants like Apple and Microsoft would have to go under.
Now, would you consider that more likely than your own bank failing?
Even as an investing beginner, you would probably instinctively know that the answer to that is no.
A safety net does exist through the Financial Services Compensation Scheme, but that only covers you up to a certain level. More to the point though, will your bank account have a higher or lower probability of actually losing you money over the next 10 years?
I can tell you with some certainty that if your money had been held in a bank account with anything close to immediate access over the past 10 years, it would have gone down in value thanks to the effects of inflation.
Since emerging from the Global Financial Crisis of 2007-2008 we live in a low interest world. Mercifully, inflation has been low too, but the cost of living has still increased by more than your bank will have paid you, and there are no signs of that changing in the short term.
In that sense, cash is one of the highest risk assets you can hold. It almost GUARANTEES you a loss in the current environment.
Over any 10 year rolling period since 1926, cash has outperformed stocks just under 15% of the time. It has never outperformed over a 20 year period or more.
So why is it considered lower risk? The answer to this is in how we are encouraged to define risk…
If when thinking about risk you focus on the variability of the return, i.e. how likely it is that the physical value of your money will fluctuate from year to year, a stock market investment will definitely be more variable and by that definition, higher risk.
However, if you think in terms of which has a higher probability of making or losing money over the long term, there is massive evidence to suggest that a stock market investment is actually lower risk because it is far more likely to produce this better return.
When investing for the long term, if you are not accepting stock market risk you are leaving money on the table and damaging your chances of success. It’s important for any investing beginner to learn this early on!
2. NOT AUTOMATING YOUR SAVINGS
As Warren Buffett once said “Do not save what is left after spending, spend what is left after saving.” In other words, pay yourself first.
On the day you get paid, a sum of money should leave your bank account and be invested. This sum should be calculated simply so that it leaves you with enough to meet your other expenses and provide you with some enjoyment! It should happen automatically, and you should not have to think about it.
This is the best way to circumvent pesky ‘behavioural biases’. Basically, if you allow yourself time to think about something, you’re less likely to do it. Sometimes that’s a good thing! But when it comes to regular investing it’s usually a bad thing.
Behavioural biases are there to help us process information and make quick decisions. This can be extremely helpful when we have to process such massive amounts of information by the second. However, they can also play tricks on your brain.
Observe these two tables below…
Let’s say you were trying to choose the most suitable coffee table for your living room and you needed to take a guess at the dimensions of each. What would you say they are?
Just by looking at them you’d know that the table on the left is much longer and narrower than the other one. Am I right?
Now take your ruler to them. You’ll probably be shocked to learn that the dimensions are identical.
Your brain is playing tricks on you – your judgement is biased. Don’t worry, that means you’re human!
This just serves to illustrate that it is sometimes best to remove our brains from the process of regular investing entirely. They frequently hinder rather than help us and any investing beginner must recognise this.
If you are interested in understanding behavioural biases in order to make better decisions on all manner of things, a brilliant book to read is the best-selling ‘Nudge’ by Richard Thaler and Cass Sunstein:
3. CHASING GAINS – THE MISTAKE ALMOST ALL INVESTING BEGINNERS HAVE MADE
It’s easy to do. I’ll be the first to admit that I have fallen into this trap myself in the past – as have many investing beginners.
Observing the performance of something that has done really well, abandoning your existing strategy to jump on the bandwagon and get in on the action is a popular thing to do… but more often than not is a big mistake.
The most famous chart to illustrate this is what we in the financial planning profession call the ‘patchwork cloth’:
This chart shows the discrete year performances of a variety of major asset classes.
Suppose you had noticed the stonking performance of ‘Hedged Global Bonds’ between 2000 and 2002. Then at the same time you decided that enough was enough with your ‘Europe ex-UK Equity’ funds. If you had decided to cash your chips in and swap these investments, you would have been regretting that decision by the end of 2003!
2003 happened to be a good year for assets generally, with everything in positive territory, but your new investment would have returned you 5.5% versus a massive 29.7% if you’d stayed put… You’d have missed out on 24% growth in one year.
Look at the following three years as well… It’s likely this would have left tears in your eyes.
This is a great reminder that diversification is key. Buying a globally diversified portfolio of stocks tends to serve you very well in the long run.
4. PAYING TOO MUCH IN CHARGES
I’m not going to get too heavily into the debate here about whether active fund management is really worth it. I believe there are cases where it can be and there are definitely some excellent investment managers in the world, but it’s hard to argue against the fact that they always start at a disadvantage.
For the unversed, active fund management is the premise of using a professional manager or managers to invest your money through the structure of a collective investment fund. The opposite to this is passive or ‘index based’ investing, where you effectively buy all of, or a sample of the companies in a stock market index.
The active manager’s job is to selectively pick assets in line with a broad strategy, with the aim of beating the market or some other benchmark (such as a list of similar funds with broadly the same strategy).
Active managers allocate to areas where they feel there is greater opportunity, and avoid areas where they feel there is less in order to seek out better gains through what is called ‘alpha’ (outperformance above the market).
The downside is you have to pay for this through higher fund charges, invariably taken as a percentage of your total investment. Managers therefore have to cover this extra cost, which can be as much as 1%-1.5% a year more, as well as generating additional performance on top.
The fact is that it is very difficult to do that consistently. So difficult, that very few actually manage to do it.
There are many reasons for this which go beyond the scope of this article, but perhaps the single biggest factor is cost.
If you’re investing for the long haul, you can gain exposure to pretty much the whole world through index funds and ETFs (Exchange Traded Funds) for very little cost at all. These have for the most part outperformed the majority of their active counterparts for a long time, so it really is hard to make a case against them.
Many an investing beginner has fallen into this trap in the past.
Like one industry commentator recently said: ” It’s not about active versus passive. It’s about high cost versus low cost.”
5. TIMING THE MARKET – NO INVESTING BEGINNER WILL SUCCEED!
You can’t do it. Not consistently anyway. So it really isn’t worth trying.
There isn’t an investor in history who has managed to call the top or bottom of the market with any regularity, but many people still persist in having a go!
Of course, if you’ve been happy with your return and are preparing to use your capital in the short term, there’s nothing wrong with selling if markets are looking a little uncertain. You may forego some growth, but that’s a small price to pay.
Holding off making a long term investment because you think things look a little dicey at the moment is a mistake. The worst mistake of all though is selling wafter a market crash to prevent further losses, when you really don’t need the capital yet… This is the real killer of performance and the reason that most people have been ‘burnt’ in the past.
Check out this chart from J.P Morgan, which shows the dramatic effect that being ‘out of the market’ for just a few short days can have on your long term performance:
Investing $10,000 into the S&P 500 Total Return Index on 1st January 1999 and just leaving it there until 31st December 2018 would have seen it grow to around $30,000; an annualised return of 5.62%.
If you’d missed just 10 of the best market days (not years or months… DAYS) in that 20 year period, your investment would be worth under $15,000. HALF of what it would have been by leaving it alone.
SIX of the 10 best days over that period occurred within TWO WEEKS of the 10 worst days.
This really does underline the importance of not attempting to time the market.
To Conclude: The 5 Mistakes To Avoid As An Investing Beginner…
So, to round it up:
Take calculated risks with your investments.
Make sure your investments are automated.
Be open to long term investment and don’t jump on financial bandwagons.
Don’t pay too much.
Don’t try and time the markets…
If you follow these tips you’ll soon turn from an investing beginner into an investing expert, and be well on your way to sipping cocktails on the beach in your retirement!
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Until next time!