We live in an age of instant access to awe-inspiring amounts of information. I can learn almost anything from the comfort of my living room: a few well placed Google and YouTube searches will tell me how to remodel my kitchen, play the guitar, or diagnose a skin rash. It's all fantastic stuff, but there are perhaps more permanent consequences for do-it-yourself (DIY) investors who make these common mistakes.
10 - Performing coffee table financial analysis on publicly traded investments:
The hunt for underpriced securities is competitive. Asset managers of a variety of shapes and sizes scour the investment world continuously to find undervalued securities. They are organized, have teams of full time professionals and have considerable resources at their disposal. To use public financial information (much which has been available in the market for weeks and months) to come up with a better interpretation of market value on your own is a tall order.
9 - Thinking that because you're a small investor you're a fast investor:
Yes, in business and in hockey smaller players can use their size to gain a competitive advantage. Unfortunately this doesn't apply in capital markets, where well capitalized high frequency traders measure their transaction speeds in micro seconds; I'm afraid no one clicks a mouse that quickly.
8 - Looking for patterns:
What goes up must come down, or if that doesn't work then what trends upward should continue to trend upward, and when that doesn't work what goes up will go up to a point, come down a bit, but then should go up again.
The activity of studying past markets in order to predict future movements is known as technical analysis. Many academic studies have refuted its usefulness, but even if it were to work, realize that your competition in this area are teams of mathematics PhDs that have come up with algorithmic trading models complex enough to require banks of computer servers to run them.. Love 'em or hate 'em, we're best off acknowledging that what these people have come up with is probably better than our arbitrary high and low watermarks.
7 - Thinking that you're one step ahead of the markets:
Capital markets are fluid and fast moving. Thinking you might have an informational advantage because you keep one eye peeled to BNN 24 hrs a day could be dangerous. Likewise, reading the weather almanac to predict product demands is not an inherently bad idea, but you or I are unlikely to outwit the teams of meteorologists on staff at the larger investment firms.
6 - Thinking that your $9.95 or $6.95 trades cost only $9.95 or $6.95:
The bid-ask spread is the difference between what you sell a security at and what you would buy it at if you were to do both at exactly the same time. It's not zero! Add this to your trade cost, along with currency fees, and you're closer to the true cost of your transaction. Do a few of these and that evil "high fee" mutual fund you sought to avoid might start to look like a bargain.
5 - Busy life, forgotten portfolio:
Yes do it yourself investing was a lot of fun at the beginning, if felt good to fire your advisor. But since then life has taken over. The questions of: Rebalancing? Investing last year's RRSP contribution? And balancing the use of corporate RRSP, and TFSA accounts tends to take a back seat. Procrastination can quickly become the simplest and most likely course of action.
4 - Having a bad plan, or having a good plan that you abandon:
It's one thing to be a high risk investor in a growing market, it's quite a separate issue when markets are tanking. Abandoning your plan can have disastrous consequences for now and in the future. Having a smart plan and sticking to it is paramount.
If you feel somehow that you're being lazy by seeking outside help keep in mind that many trained finance professionals opt for outside oversight of their own finances for precisely this reason. It's tough to remain disciplined in your own finances when it's demanded of you.
3 - Lacking diversity:
I recently heard a real-estate fund salesman call diversification diworsification.
Diversification is not a diffusion of your investments, nor is its effectiveness up for debate.
A collection of non-correlated assets will perform better on a risk adjusted basis over time than a collection of correlated assets. It's a mathematical fact, and diversification is one of investors' only allies. Resist the temptation of picking your favourite 6 stocks and calling it a diversified portfolio. It's not.
2 - Making mistakes:
Yes you might end up buying Nortel, and that was a mistake, but there's also the mistake of buying "RYL" rather than "RY", when you really meant to buy "R", and which market did you want that on anyway.
My career favourite is from a statement where a DIY'er attempted to buy the iShares gold trust "IAU:NYSE" but mistakenly ended up with "IAU:TSX" (Intrepid Mines) instead. The good news: the position struck gold, almost literally, Intrepid Mines is up over 500% being one of the success stories of the junior mining world. The bad news: the number of shares bought resulted in an order 100 times smaller than originally planned - Intrepid Mines was a penny stock.
The phenomenal returns resulted in a net position capable of funding its trading commissions and buying a few MacDonald's value meals.
1 - Temptation over discipline:
Execution of hot stock tips, (or market, or commodity tips) is just a few clicks away, for most DIY investors that's far too close.
Written by Ian Collings