6 common investing mistakes and how to avoid them
Cheap brokerage, low interest rates and government handouts drove a record number of new investors to the stock market in 2020. According to a report from ASIC, 140,231 new investors made their first direct share purchases between 24 February and 3 April last year. While many are no doubt feeling confident after strong returns in the second half of the year, there’s no replacement for experience and wisdom. Though we can’t force experience to come any faster than a day at a time, we can learn from the wisdom of others who’ve been there before us. As Isaac Newton famously wrote, "If I have seen further, it is by standing upon the shoulders of giants".
I recently reached out to a range of Livewire contributors who either deal directly with the investing public, or who have a particular interest in the psychology of investing. In this wire, they each share a common investing mistake they’ve observed, and some ideas on how to avoid them.
Responses come from:
- Matt Joass, Maven Funds Management;
- Rudi Filapek-Vandyck, FNArena;
- Chris Leithner, Leithner & Company;
- Roger Montgomery, Montgomery Investment Management;
- Jordan Eliseo, The Perth Mint;
- Steve Johnson, Forager Funds.
Let your neighbour get rich
Matt Joass, Maven Funds Management
The biggest mistake you can make is trying to copy others instead of developing your own style and approach to suit you and your family’s needs. This includes following a friend’s hot tips because you are afraid of missing out. As JP Morgan said:
“Nothing so undermines your financial judgement as the sight of your neighbour getting rich.”
Let your neighbour get rich. If your friend is making a fortune on risky investments, cheer for their success. But stay true to your own strategy for generating wealth. The race is long, and in the end, it’s only with yourself.
If you are not yet sure what your style is then read widely and try a lot of different investment styles on for size. You will know your style when you find it. The whole investing world will suddenly click into focus.
PEs are not a static concept
Rudi Filapek-Vandyck, FNArena
Long before investors fell in love with technology and disruption companies, savvy investors had figured out many a stock trading on an above-market price-to-earnings multiple was likely to weaken in between February and August. Call it a seasonal pattern if you like. The reason was simple and straightforward: as the end of the financial year was near, the PE multiple based on the year about to finish looked bloated, so retail investors started selling.
Of course, in most cases growth continued, and with forecasts intact and institutional investors looking two to three years' ahead, those share prices would recover not long after. This is but one example of the most common mistake made by investors: treating PE ratios as a static indicator.
When BHP shares fell to $13 in 2016, the PE had risen to above 80-times. High PE means expensive? Think again. What is needed is context, which requires insight and an understanding of why a PE is where it is, plus an assessment of what is likely to happen next.
The best advice for investors is to ignore the noise stemming from “experts” reading PEs as a static indicator. Next start educating yourself. Maybe pay more attention to price targets, as I do, but don’t make the mistake of treating those as set in stone either.
Invest, don't speculate
Chris Leithner, Leithner & Company
One common mistake investors make is forsaking investment and embracing speculation. Specifically, they greatly overestimate the importance of – and thus overreact in response to – “noise” (today’s opinions and “news”); as a result, they ignore real information – namely longstanding odds. They become excited about “hot stocks;” yet these generally produce poor long-term results.
Above all, disavow speculation! First, discount recent developments. If you’re considering X Ltd’s shares, then examine its financial statements for at least the past five (and preferably 10 or more) years. Second, don’t attempt to assemble every fact and weigh every possibility: whatever data you collect and analyse will be incomplete, ambiguous and contradictory. Instead, gauge the long-term record – the tendency towards success or failure – of courses of action like the one you’re proposing. Ask yourself: “in the past, what’s generally resulted from the purchase of such a company’s shares at a PE, dividend yield, etc., such as these?”
The best time to plant a tree
Roger Montgomery, Montgomery Investment Management
Perhaps the most common of all mistakes is to wait too long to start. The title of the biography of Warren Buffett, maker of the epochal fortune from investing in others, is The Snowball. The title provides arguably the most important instruction for any investor; start early. Starting immediately offers the longest runway, which provides the greatest opportunity for compounding to perform its magic, while also permitting time to recover from all the other mistakes mentioned in this feature.
It is common and apparently rational to ‘wait for better prices’, to wait for a correction or sell off before starting. And yes, sequencing risk is real but it is however a mistake to wait if you have regular income from a job or other source. Better to start now and remember to buy investments the way you buy groceries - more when they’re cheaper and less when they’re expensive. Oh, and you may get rich buying and selling but you get wealthy from buying and holding.
Don't chase recent performance
Jordan Eliseo, The Perth Mint
One of the more frequent issues is investors chasing recent performance, with investment flows into an asset class often peaking either as the asset class itself is peaking, or shortly after. It’s understandable why this happens, as investors naturally feel more confident putting money into something that is already performing well, especially when the strong performance of the asset class in question will likely be accompanied by:
- Positive media coverage about the recent performance of the asset class, and
- Speculation that the strong performance will continue.
One thing that might help is for an investor to consider a strategy like dollar-cost averaging. Following this will mean that investors will never pile all their money into an asset class at the ‘wrong’ time just because it’s performed so well and is getting lots of coverage, though it also means they’ll never fully capture the potential performance upside from an asset class that is very cheap.
Don't be fooled by randomness
Investors often confuse good luck with a high level of skill. A few successes breeds overconfidence and overconfidence leads to horrible outcomes down the track. This is as true of us professionals as it is new investors. Have you noticed that every time we are underperfoming the market, fund managers have lots of beautiful charts showing how some factor or market segment isn’t working and that it is only a matter of time until our investments come good? Yet when we are outperforming, it’s all attributable to our wonderful stock picking abilities?
Luck and randomness have a huge influence over short-term results. Investors need to recognise that, especially when things are going well.
I’m an advocate of writing down your rationale for buying a stock at the time of purchase. It can be as simple as “I am buying this stock because I expect the following five things to happen over the next few years”. Doing so allows you to separate what is happening with the share price from what’s happening to the business, relative to your expectations. That’s my main tool for assessing our performance. I use it to keep the egos at bay.
Whether you're a brand new investor looking to make your first purchase, or a seasoned veteran who's seen a cycle or two, these timeless principles are applicable to all of us. Most of us tend to learn the hard way - by losing money. But heed this advice, and you might just be able to pick up a lesson or two the easy way.
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Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.
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