Classic Mistakes Investors Make

Fifteen years ago, American investor Kevin Vogelsang caught the bug for buying Chinese stocks. He took a position in FAB Universal Corporation, a brand created in 2008 that had over 12,000 self-service kiosks located throughout China where customers would download music, movies, and TV episodes while watching video ads. After several tumultuous years, by 2017, FAB Universal finally ceased operations, making the shares worthless. Looking back on the experience in the Wall Street Journal, Vogelsang admitted he should have paid more attention to the company’s AMEX ticker: FU.

Benjamin Graham, the father of value investing and a mentor to Warren Buffett once said, “To be successful, people don’t need extraordinary insight or intelligence. What they need most is the character to adopt simple rules and stick to them.”

As DIY investors, despite the reams of information (or maybe because of it?), we still manage to get in our own way. Despite these errors, the aggregate of our investments usually works out okay—over the long term. Nevertheless, by avoiding common missteps, we’d likely have more chart-topping hits.

Penny Lane: Let's Get Nominal!

Most investors focus on returns in purely dollar terms. However, having a portfolio balance of $1,000,000 is not the same as the real return. That’s because the real return includes costs such as taxes, investment fees, and inflation. Whether there is a sharp rise in inflation, as in 2022 when rates rose over 8% in Canada, or a more “normal” pace of between 2-3%, the cost of living continues to rise. Investment management fees also take a bite. Taxation rates change, as we saw recently with higher inclusion rates on capital gains in corporate accounts. Are your investment returns keeping up with these rising costs? After deducting taxes, fees, trading costs, and inflation, what is left over is the real return that can be used for buying goods and services in real life.

Historically, being a part owner in a business (equities) outperforms being a lender (bonds). Thus, owning equities has protected buying power better because corporate profits drive equity prices, making them less susceptible (but not immune) to high inflation. Without letting the tax tail wag the dog, always be mindful of the effect of taxes and other costs in calculating your real returns which represent your true spending power.

Hello, Goodbye: Tax Loss Selling, Knowing When To Sell

The financial media and analyst reports are awash in recommendations to buy, but remarkably reticent when it comes to volunteering selling advice. One reason is no one who wants to keep their job, is willing to be on the wrong side of a company by advising investors to bail on it.

Capital markets run on lucrative fees on Initial Public Offerings (IPO), capital raises, bond issuances, mergers and acquisitions and the like. Career risk is real, and it increases exponentially for those who publicly share negative assessments of a company. That leaves most DIY investors on their own to decide the right time to sell an asset. While there are many excellent reasons to sell, such as taking profits, a change in the investment thesis, estate planning, and portfolio rebalancing, weak reasons to sell include “advice” from stock trading chatroom posters, friends, and financial media pundits, or just sheer boredom. Obsessively checking our holdings can engender a feeling of impatience which could lead to selling an asset prematurely and missing out on compounding returns.

Oh, Darling: Crowded Trades And Failing To Diversify

Sometimes what started out as a small holding suddenly represents a larger proportion of your portfolio. It’s a nice problem to have (just ask investors in the Magnificent Seven), but it’s still a problem. Having more than 10% in any holding puts your financial health at risk, yet the average U.S. investor has over 40% of their portfolio in just three tech companies!

Crowded trades, such as the current penchant for the Magnificent Seven darlings which make up nearly 35% of the S&P 500’s total value with Apple, Microsoft, Google, Meta, and Amazon alone representing over $10 trillion in market value (November 2024), could also leave investors high ‘n’ dry when the tide goes out.

Studies have shown that a diversified equity portfolio should have between 30-40 stocks representing different sectors and capitalizations. Legendary bond investor Bill Gross learned an expensive lesson in his youth while playing Blackjack: no bet should be greater than 3% of your liquid net worth. Unlike gambling, investing requires careful use of capital and avoiding unnecessary risk through leverage or outsize positions.

Employees in public companies face a similar risk when part of their compensation is in company shares or stock options. Both their earned income and their potential investment gains are in lockstep and overly dependent on one company/sector. They may also own company stock through mutual funds and Exchange-Traded Funds (ETFs), further increasing their exposure. Over time, even well-diversified portfolios can become lopsided. It’s important to keep track on a quarterly or bi-annual basis and, painful though it may be, reduce exposure to big winners if they are changing the risk profile of your portfolio.

Come Together: Resilience And Risk

Investors tend to focus on returns, but do not always factor in the risks needed to achieve those returns. This may be especially true for investors as we graduate from the accumulation phase to the decumulation phase, where chasing performance should take a backseat to capital preservation and portfolio resilience. In some cases, investors assume unnecessary risk to generate the returns they need to maintain buying power.

It’s not your imagination, the world is more volatile than in the recent past. It would be prudent to heed the adage: “Past performance is no guarantee of future results.” Recency bias has predisposed investors to lean into U.S. large-cap equities because they have outperformed since the Financial Crisis in 2009. The S&P 500 has returned nearly 15% annualized during this period to the end of 2024.

Yet, as Warren Buffett has said, “Trees do not grow to the sky.” Shifting our focus away from purely looking at portfolio returns to portfolio resilience can protect us from catastrophic losses which could permanently impair capital.

The Long And Winding Road: Have A Financial Plan

Stocks and bonds are common investments, but another key investment is having a financial plan. Hiring a certified financial planner who is also a fiduciary will likely involve writing a cheque for their services, which some of us are reluctant to do. It may also be possible to find advisors who charge hourly fees to review your financial position and make recommendations. Hiring a fee-only financial planning expert who is not selling you products is a sound investment. That’s because despite the popular image of the lone, DIY investor, investing really is a team sport. Your team should include a trusted fiduciary advisor.

According to the Manulife Financial Wellness Survey (2022), those with a financial plan are even more likely to report being in a good financial position (74% vs. 68%), ease of saving money (41% vs. 36%) and on track for retirement (55% vs. 47%).

Looking at your investments holistically (Registered Retirement Savings Plan (RRSP)/ Registered Retirement Income Fund (RRIF), Locked-in Retirement Account (LIRA)/Life Income Fund (LIF), Tax-Free Savings Account (TFSA), non-registered accounts, insurance, etc.) is essential. Taking the time to honestly write down your personal and financial goals is the first step in making sure your investments are working for you in the right way. This will reduce financial stress and increase life satisfaction as decision-making becomes easier.

Rita Silvan, CIM, is a finance journalist specializing in women and investing. She is the former editor-in-chief of ELLE Canada and Golden Girl Finance. Rita produces content for leading financial institutions and wealth advisors and has appeared on BNN Bloomberg, CBC Newsworld, and other media outlets. She can be reached at rita@ellesworth.ca.