Top 5 Bad Behaviors in Personal Investing
We are all just human and we tend the make the same mistakes over and over. Perhaps by reading this list, you can avoid some of the most common mistakes we see when people invest and manage their money.
Not Diversifying your Portfolio.
It is easy to fall into the trap of finding a good investment and putting all your money in that “good investment” only to experience an unexpected reversal. We are reminded of a story of an investor who put most of his retirement funds into the stock of the company he worked for - both in and out of his RRSP. The stock was consistently returning 10-15%/year and he was pretty pleased with his good fortune. But of course, the company fell into some hard times and eventually went bankrupt, wiping out his retirement funds and, of course, he lost his job in the process.
The purpose of diversification is to avoid putting all your eggs in one basket and making your return more predictable. The more you diversity, the less likely you’ll see unexpected returns. Read more about diversification <here>.
Investing in Things you Really Don’t Understand.
Blockchain is hot and you’ve heard about this start-up that has some product related to Blockchain – maybe you should invest? Marijuana is going to be legal across Canada – maybe I should invest in a grow-op? My friend made $1,000,000 investing in Blockchain <read about it here> – maybe I should get into Cryptocurrency.
Sure, some of these investments are fun and if you can afford it, go and invest what you can afford to lose – similar to money you might spend in a Casino – and certainly no more than 5-10% of your total portfolio.
But for your serious investing, stick to things you understand. If you are a complete beginner, look at Mutual Funds or Exchange Traded Funds (ETFs). As you learn more you can move into more complicated strategies and own individual stocks, real estate or other assets. Or you can just have a professional help you.
Not changing your investment strategy over time.
When you are just starting out you’ll often hear the advice that you should overweight in equities (stocks) with very little in fixed income (bonds) and cash. But many get comfortable with that strategy, especially when investments in equities have generated great returns for the patient investor (Average return over the last 20 years for the S&P/TSX has been 7.0%)
But as you get older and closer to retirement, swings in the equity markets can wipe out profits quickly, as we recently experienced. Picture how you’d feel if you planned to retire in early 2018 and see 10% to 20% of the value of your portfolio eliminated in a few days. Of course, we now know that you would have recovered a lot of your losses in the months that followed, but that hasn’t always been the case in the past.
As you get older, your risk tolerance should drop which means changing your asset allocation away from riskier, more volatile investments (stocks) to less risky, less volatile investments (bonds and cash). We talk more about asset allocation <here>.
Starting to save for retirement “someday”.
And you know that for most people, “someday” never comes. We describe on our website the huge difference between someone who starts saving at 20 and someone who starts saving at 40 thanks to the virtuous cycle of compound interest/compound returns. The person who invested at 20 will have 4X times more money at age 60 than the person who started to invest at 40 – even if they ultimately invest the same amount (40 year old “catches up” buy investing double over 20 years what the 20 year old invests over 40 years).
Our advice is to start a saving plan as young as possible, even with just a small amount of money. It will start a great habit and begin accumulating compound returns quickly.
Not using a Professional to Help.
You don’t know what you don’t know and that can be financially fatal. One story was of a woman who pulled money out of an RRSP to pay for an unexpected expense rather than taking out a short term loan (1-2 months) on their credit card as they had been told to avoid credit card debt “at all costs”. While we are always in favor of limiting credit card debt, in this case the decision was very bad. In addition to losing out on the tax-free growth inside the RRSP, the client paid a significant early withdrawal penalty. Further, when this woman discussed this situation with us, we learned that there were other strategies she could have taken to avoid withdrawing from the RRSP or taking on credit card debt. In her case she could have got a loan against her life insurance.
While not everyone needs a full time Investment Advisor, we all must be aware that there are times that we need to call in the Pros. If you are unsure, ask for help. There are very low cost and no cost ways to get advice, including reading about how to make smart investments on our site!