A new reader asked this week for my advice on successful investing. Like too many investors, she had a “cocktail” portfolio – a mismatch of stocks that promised quick gains. There was no investment strategy, she overtraded and returns were not benchmarked.
I’ve seen this problem too many times over the years. In the hunt for “winners”, novices buy too many stocks and unwittingly speculate rather than invest. They try to second-guess the market (and millions of investors) rather than think like company owners.
Here are five of 10 classic investment mistakes I explained to the reader, and how to avoid them. I’ll cover the remaining five (which focus on company analysis) in next week’s column for The Bull.
1. Deafened by noise
If you subscribe to pay-TV, watch US business channel CNBC for 10 minutes. Even in that brief period you’ll probably get half a dozen opinions on markets or stocks. Most bullish, some bearish, and conflicting views every few minutes.
Different opinions, of course, make a market. But being influenced by “market noise” – newspaper stories, tipster recommendations, online chat forums or other platforms that have an array of market commentary – is a recipe for wealth destruction.
Newspapers have a knack of printing positive stories about companies after they rally (and are now expensive) and negative ones when stocks fall (and are cheap). Most finance journalists think like reporters (their job) rather than value investors.
Follow what the media says and stick to a few trusted, independent finance platforms, such as The Bull. But don’t buy or sell stocks – or make significant portfolio decisions – based on media stories that provide general news, not specific advice.
A former colleague moved his superannuation from equities to cash at the nadir of the 2008-09 Global Financial Crisis. Having watched his super nest egg tumble during the GFC, he panicked and moved to cash at the worst possible time, despite my counsel.
The smart move was to ride out the crisis or, better still, invest more in equities when they were cheap after the GFC. But like so many investors, my friend tried to time the market and in one click of a button (changing his portfolio weightings to cash) created years of financial hardship and stress.
Academic research shows overtrading is a portfolio killer. Share investors, on average, hold too many stocks and trade them too frequently. The only ones who consistently make money from the process are broking firms and other advisers.
I don’t propose investors stick to “set-and-forget” investing and hold stocks for years without reviewing them. But sustained wealth creation in the sharemarket, for portfolio investors, requires taking a multi-year view and having a disciplined approach.
The sharemarket treats investors who look backwards, rather than ahead, like road kill. We’ve all been there: a stock that used to trade at $10 now trades at $1, so looks “cheap”. Just as the $1 stock that soars to $10 seems “expensive”.
Some of my worst investment decisions over the years have involved selling stocks too early. By focusing on where the stock had come from, not where it was going, I assumed it was time to take profits – and forgot to let my profit run.
I once invested $20,000 in a ASX-listed junior explorer in South East Asia, at 5 cents a share. The stock rallied to 10 cents, so I sold for a tidy $20,000 profit and much satisfaction. Within a few years, the stock traded above $4 – and makes me cringe to this day!
My $20,000 would have been worth $1.6 million had I held on. It’s hard to complain with a $20,000 profit, but looking back there was no rational reason to sell the explorer. My profit taking was based on share-price dynamics, not company fundamentals.
The psychology of anchoring affects investors in so many ways. For example, they buy a stock because it has a historic yield of 7 per cent, but overlook the future dividend per share. They think a stock on a historic Price Earnings (PE) multiple of 10 is cheap, but ignore the risk of lower future earnings and thus a sharply higher PE.
You’ll never create sustained wealth in the sharemarket by looking backwards or extrapolating past trends into the future. Investing is about looking ahead. 4. Risk management
I am constantly surprised at how much risk novice investors have in their portfolio. They don’t realise that in many instances owning shares in half a dozen junior mining explorers is one step up from punting on black or red at the casino roulette wheel. Others have portfolios stacked with big-bank stocks, sometimes because of legacy investment strategies or dividend reinvestment plans. Their portfolios, concentrated in a few sectors, are poorly diversified and vulnerable to industry or market downturns.
Years ago, my entire wealth was invested in Australian shares. Like many young investors, I built a share portfolio as a stepping stone to a house deposit and, later, home ownership. I never considered the risks of having so much wealth invested in one asset class.
The same is true of the reader who contacted me this week. Most of her wealth is tied up in 20 or so stocks. She hasn’t considered the right allocation across assets – local and international equities, fixed interest, property and cash. Or the right allocation within those assets; for example, sector allocations within the equities component.
Like many, she lacks an investment plan. Techniques around risk management or position sizing (how much is invested in each stock) are absent. If you want to invest directly rather the use the services of professional fund managers, develop some portfolio-management skills. Having a blueprint for how you will invest is critical.
5. Too much focus on buying
In my line of work, I come across many investors who want tips on stocks to buy. Rarely do people ask for ideas on stocks to sell. In fact, I occasionally receive negative reader emails when I dare suggest a stock is overvalued and should be sold.
Forget about paper profits. The only profits that matter are those that can be folded and put in your wallet. Too many investors spend too much of their portfolio time focusing on what to buy and not nearly enough on when to take profits or cut losses on their stocks.
Or they fall in love with a stock and find it impossible to sell. A stock that rallies from $2 to $12 has delivered so much joy that investors cannot bring themselves to part with it. So, they hold it for too long, only to watch the stock give back half of its gains.
The reader I spoke to rarely sold stocks. She bought one stock after another on the recommendation of brokers, investment newsletters, media, friends and so on. And now has a portfolio of ragbag stocks that are going nowhere because the portfolio was never pruned.
An ability to sell stocks touches on the first four points in this article. Namely, looking ahead and having a view of the company’s intrinsic or fair value. Having a clear plan as to when you will sell a stock and why. Having the discipline to sell stocks and not be swayed by market “cheerleaders” who hype stocks for personal gain. And selling because the company’s fundamentals demand it, not because of a comparison with a previous price.
Next week: The search for exceptional companies at bargain prices.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at April 27, 2017.