Why Investors Fail
This is a list of the top reasons I have seen for poor performance and discouraged investors. Your comments and shares are appreciated.
Volatility- When markets correct/fall, investors that do not have a plan or discipline will panic. Everyone has heard the cliché, “buy low, sell high” but even the smartest investors fall victim to emotion in volatile markets. Market corrections are healthy and an absolute requirement in the financial markets. Volatility creates the greatest opportunity to generate substantial returns with significantly less risk. Unfortunately, if investors do not understand volatility and the opportunities it presents, they will panic and sell when their investments fall and they will buy when the markets rise, this is the herd mentality that slaughterers so many investors wealth.
Discipline- Rather than having a plan and disciplined approach to investing, many, especially novice investors will follow the herd, buying and selling at the wrong times because everyone else is. I specifically remember speaking with investors in 2008 when global markets were deteriorating in the worst correction in history. Many panicked at the bottom and sold into cash, trying to preserve their portfolios, contrary to professional advice. It is absolutely essential to use discipline with your strategy and not to panic, without discipline, devastating mistakes will almost certainly be made.
Poor advice/uneducated- Many investors think they can strike it rich on a hot stock tip they got from a friend, website, or even worse, the news. We need to remember one thing about media companies; they get paid to sell news, not advice! If you are serious about the long term performance of your investment portfolio, you need to do your research, educate yourself and partner up with a proficient advisor who can help you implement appropriate strategies, weigh the merits of certain investments and most importantly, devise and implement a long term investment strategy designed for you and your specific goals.
No plan- I have worked in the financial industry for 9 years and have met with people from all walks, from business owners to professionals, affluent families to young families starting out and one common theme has always emerged; NO PLAN. I would estimate (although I have not kept track) that less than 5% of people introduced to me had a detailed financial plan outlining their roadmap to financial success. I have met many who thought they had a financial plan, but what it really was, was a collection of financial information with basic projections- This is NOT a financial plan. With a proper investment plan and investment policy, you will most certainly make solid decisions as you will have to discuss and understand the implications of any decisions prior to making them.
Under-diversification- This is fairly straight forward, having a significant portion of your wealth tied to either a limited number of investments or a limited number of sectors and geographies. Most often I see this with people who have a stock option plan through their employers or with people who have made significant gains in previous investments who believe these investments will continue to grow. This is also prevalent with real estate investors and executives whose compensation packages involve company shares, etc. For obvious reasons, being under-diversified can present significant unnecessary risks within ones portfolio.
Over-diversification- This is, in my opinion, one of the worst mistakes an investor can make. In many cases, an over-diversified portfolio is the result of trying to “diversify” without understanding how to successfully do so, resulting in terrible performance and potentially increased risk. For example, I recently met with a referral to review their financial plan and investment portfolios. After a comprehensive analysis, we found that they held several of the same investments with several institutions. In this case, these were primarily mutual funds. Digging further into this analysis, we discovered that this couple not only had several identical mutual funds at different institutions, but 5 of the funds held the same top holdings throughout their portfolio. This over-diversification had resulted in unnecessary under-performance, inefficiencies and expenses.
Speculating- This is the biggest misconception with investing. Many investors do not know the difference between speculating and investing. To me, speculating is the art of aimlessly gambling/buying investments without fully understanding what you are getting yourself into, usually because of a hot tip from an uneducated or ill-advised friend, colleague, family member, etc. These "investments” are typically made with unrealistic expectations regarding returns, risks and time-frames. It is usually these people who have been stung with bad investments who you will hear saying that they have never made money in the market. Prudent investing on the other hand, is a process where you, your advisor or both research and understand your investment plan, holdings, their risks, valuations, correlation, etc. to understand if they are in-fact good investments, within your risk tolerance and properly diversified. This is perhaps oversimplified but I think you get the point.
Buy & Hold isn’t good enough- This is a time tested strategy that has been proven to be effective with managed money (mutual funds, etf’s, etc.). The problem is that this approach, although effective, is not as efficient as it could be. The idea behind this concept is simply that companies and economies will grow over-time and the results will be reflected in your portfolio.
The process of rebalancing MUST be used on a strategic basis within your portfolio. Rebalancing is simply the process of ensuring that your allocation weightings are brought back in-line with your investment policy and risk tolerance in order to safeguard you from being overly exposed to undesirable risks. On a return front, this process also ensures that you are buying low and selling high and taking the emotion out of your decision making process. To simplify, imagine you held 2 asset classes; 50% equity, 50% fixed income. If you held this balance at the beginning of 2008, the equity component would have significantly dominated the portfolio through 2011 resulting in a portfolio structure much different than originally intended, probably now looking something like 80% equity, 20% fixed income. This portfolio now represents excessive risk but more importantly, it presents the opportunity to sell 30% of your equities while markets are high and allocated that to the more conservative fixed income component. When the markets fell in 2011, you would have been back to a 50%-50% allocation of which 0nly 50% was meaningfully affected by the declining equity market as opposed to 80%. That being said, you would have had a significantly larger value allocated towards fixed income when markets fell which appreciated during this time. In short, a rebalancing process is designed to buy low, sell high, reduce risk and enhance returns. If you are not doing this, you should be!
Cost Basis & Taxes- Many investors let cost basis and taxes strongly influence their decisions to sell positions. For example, if you purchased an investment in 2008 at $10,000 in a non-registered account which enjoyed strong growth and is now worth $50,000, you would have a $40,000 capital gains if sold. This would result in a tax bill of (assuming a 40% MTR) of $8,000. When faced with the decision to sell this investment at its high to reduce risk and reallocate to other opportunities, the $8,000 tax implication often results in the decision to do nothing. Although taxes are an integral part of the decision making process, they should not be the sole focus of your decision.
Investors should consider maximizing their tax-free savings accounts and RRSP’s before using a non-registered account, but when they do, a Corporate Class structure should be considered. This structure allows investments to be bought and sold within and NOT incur taxes until they are sold outside of this structure. When the funds are needed, say for retirement income, there is potential to draw from this account tax-free for 20+ years.
Consistent Saving- Once you have put in the work to understand your portfolio, investment techniques, etc. or decided to work with a quality advisor, the easiest thing you can do is invest regularly in a high quality portfolio for a long period of time. Lots of people don’t have $500,000 to invest right off but almost everyone, with discipline, can invest a few hundred dollars per month. It is my goal that every single client I take on eventually has an investment portfolio in excess of $1,000,000. With regular investing, solid returns and the power of compounding and time, this isn’t that hard.
If you have questions on your portfolio, financial plan or any other questions, feel free to get in touch with me. I would be happy to meet with you for a no cost consultation of your portfolio and financial plan. If I believe you are in good hands and your portfolio is structured property, I will let you know. If however I believe there are areas for improvement, I will outline opportunities for further discussion.