Avoid investment pitfalls
As even the most experienced investors will attest, the world of investing is riddled with hidden pitfalls that can easily trap the unwary and prevent you from achieving your investment goals.
Here are five common investment mistakes, as well as some tips for avoiding them on your own investment journey:
1. Ignoring your investment goals
The first step in any successful investment strategy is to set clear investment goals, unique to your financial situation.
Without these goals, or a clear sense of direction for your investment strategy, you could quickly fall prey to chasing fleeting market trends, selecting the wrong types of investments and continuously switching your portfolio with costly results.
Create your list of goals by mapping out exactly what you want to achieve, the time horizon for each of your goals, how much you will reasonably be able to invest, and the risk you will be willing to take with your funds. This should include short-term goals, such as saving towards an education course or an emergency fund, or long-term goals, such as a deposit on a home, a child’s education or your retirement.
For example, if one of your goals was to save R50 000 towards a deposit on a home within five years, selecting an investment product that aims to achieve annual returns of CPI plus 5% (net of fees) would mean that you would need to invest just R646 each month.
By comparison, placing your savings in a zero-interest bank account would mean that you would need to save over R833 every month to reach your goal, adding up to an extra R11 220 over five years.
2. Allowing emotions to guide your decisions
Making knee-jerk decisions based on short-term news and market movements often comes at the expense of your long-term investment results.
For example, many investors were quick to sell when the market began falling towards the end of 2018, fearing that the drop would be prolonged. However, these investors then missed out on the market’s subsequent rally, as it gained as much as 8% within the first quarter of 2019.
Unfortunately, many investors also rely on news headlines or “braai recommendations” from friends and family for investment advice rather than conducting their own research or consulting with a professional financial advisor.
This increases the likelihood of succumbing to your investment biases, missing out on market opportunities by giving in to short-term anxiety, or investing based on hype rather than objective valuations and fundamentals.
Some investors also choose to disinvest after six months or a year when their portfolios deliver disappointing short-term results, rather than giving these portfolios and their investments the time they need to perform. This not only carries tax implications, but also means that you could miss out on periods of far better growth.
3. Failing to spread your investment risk
All investments carry some degree of risk, and one of the most effective ways to manage this risk is through diversification, or by spreading your investments across different asset classes such as cash instruments, property, bonds and equities, as well as across different regions and sectors.
Different asset classes perform differently at varying stages of economic cycles, and through blending different types of assets, you will be able to “smooth out” some of the volatility or bumpiness of returns.
Unfortunately, however, many investors fall into the trap of taking a large position in a single stock or sector in the hope of achieving quick, outsized returns.
Many investors, for example, succumbed to Bitcoin fever when its price soared more than 1,000% in 2017, choosing to invest a large portion of their savings in the cryptocurrency in the hope of sharing in its success. However, these investors were left disappointed when Bitcoin’s price plummeted again in 2018, losing around 82% of its value.
Equally, it is also possible to over-diversify and limit your portfolio’s potential for growth, so it is key to strike the right balance.
4. Not considering inflation
Given the dramatic rise in the price of petrol and food seen over the past few years, all South Africans will be aware of the ability of inflation to eat into income and wealth. In the ten years between 2008 and 2018, for instance, the price of a loaf of white bread more than doubled from R5.89 to R13.49, while long-life milk rose from R8.46/litre to R13.99.
Inflation slowly erodes the purchasing power of money over time and plays a significant role in investing, as your investment’s growth will need to keep up with or outpace inflation if you are to preserve the value of your money.
Many investors make the mistake of allowing their fear of risk to overshadow the need to take on at least some investment risk if you are to achieve long-term inflation-beating returns.
You therefore need to take an investment’s real returns into account when selecting an investment and assessing its performance over time. A real return refers to the investment return over and above inflation.
5. Ignoring the impact of fees
Many investors are not aware of the fees they are paying on their investments. It is vital to consider your investment’s cost implications, as fees can have a significant impact on your investment outcomes.
For example, take two investors who each invest R1,000 every year in a portfolio for 40 years, which then achieves an average return of 10% per annum before fees. However, the first investor’s total fees cost 3% per annum, meaning that their investment only grows to R192,670. By contrast, the second investor’s total fees cost just 1% per annum, meaning that their investment grows to a handsome R355,944 – nearly double the first investor’s result.
When comparing investment options, investors should therefore consider each portfolio’s Total Expense Ratio (TER), which measures the total costs associated with an investment, and whether the portfolio offers value for money. You will also need to factor in any other additional expenses such as advice or platform fees.
If any of the costs associated with the investment are not clear, request these figures from the investment provider before committing to the investment.