In this series of posts we're looking in detail at 7 of the most common mistakes that investors make. In this post, we'll be looking at mistake number 6, 'not keeping score' and mistake number 7, 'investing too conservatively'.
If you would like to know more about this and other investing mistakes to avoid, please just download our free report The 7 Biggest Mistakes That Investors Make.
Mistake number 6: Not keeping score
Overconfidence is a decision-making bias that humans are prone too. Psychological studies show that, although people differ in their degrees of overconfidence, almost everyone displays it to some degree. For example, much more than half the population claim to be above average drivers, or have an above average sense of humour. There is also a tendency for individuals to place too much confidence in their own investment decisions, beliefs and opinions.
To avoid overconfidence in your own investing, our suggestion would be to carefully document and review your investment record. It's easy to remember the fund you picked that gained 50% in a 12-month period, but your records may reveal that most of your investments are under water for the year. Overconfidence stems from inexperience. For instance, more than 70% of naive investors wrongly assume they are enjoying above-average returns.
Also, bear in mind that professional fund managers who have access to the best investment industry reports and computational models in the business can still struggle to achieve market-beating returns. The best fund managers know that each investment day presents a new set of challenges and that investment techniques constantly need refining. Just about every overconfident investor is only a trade away from a very humbling wake-up call.
The important thing to remember is to always look at your total portfolio return and this is easy to do. Simply look at what your account is valued at each year on January 1st and make a note of any additions or withdrawals you make throughout the year. At the end of the year –December 31st – make a note of what your account is valued at. If you have added any money, deduct the amounts from your end of year figure.
And if you have withdrawn any capital, add the amount to your end of year figure. For example, if you started the year at £100,000 and ended the year at £110,000, and you hadn’t made any additions or withdrawals during the year, you know you’ve made a 10% gain. Here’s another example: you start the year at £100,000, add £10,000 during the year and end the year at £120,000. Once again you can say you’ve made a 10% gain.
And a final example would be if you start the year at £100,000, you withdraw £10,000 during the year and end the year at £100,000. Once again, you can say you’ve made a 10% gain. The final step is to compare your annual performance versus the market with the goal being to outperform it. To keep it simple, see if you’ve beaten the FTSE 100. If you have, congratulations are in order. If you haven’t, you may need to rethink your strategy.
Mistake number 7: Investing too conservatively
Most investors understand that growth funds are a great and appropriate vehicle if they have a long time until retirement. However, many investors in their late 50s and 60s – approaching retirement or already in it – have been coached by media and industry professionals to think about their investing time horizons in a way that, in our view, is all wrong and one of the most frequently made investing mistakes.
These people naturally think that their investing time horizon ends when they either retire, stop contributing to their retirement funds, or start taking cash regularly from their portfolio. They mistakenly think that’s when they should reduce most, if not all, volatility risk and start thinking ultra conservatively. In our view, this can frequently lead to an unnecessary and sometimes serious reduction in quality of life later on. Why? People live longer than ever now, yet many invest, by and large, like they expect to die at age 70.
According to the Office of National Statistics, the average 65 year old male will live until they are 83 but some 65 year old men will beat this average and live longer. Therefore, if you’re 65 years old or approaching 65, our suggestion is to adopt a long-time investment horizon, especially if you come from a long living family and are in good health. Many investors approaching their retirement mistakenly think reducing risk is smart by moving out of equities and into bonds and cash instruments.
It’s true that having an ISA or SIPP portfolio of gilts and cash won’t be as volatile, but volatility risk is just one kind of risk. A 2010 poll conducted by Allianz Life Insurance Co. in North America, of people aged 44 to 75, found that more than three in five (61%) said they fear depleting their assets more than they fear dying. By thinking too short-term, many investors approaching retirement invest too conservatively.
It can mean that they get poor returns, fail to stay ahead of inflation and, as the years pass by, their retirement pot slowly but surely gets smaller and smaller. We think it’s a big gamble to believe that you and your spouse will be just average and live another 10 years – then find out you're abnormally healthy, live another 20 or 30 years and run out of money after 10.
Plus, it's later in life that you'll want the additional comforts money can buy. Seen that way, investing too conservatively could be seen as high risk. If you are approaching or in retirement and you extend your investment time horizon, you may then decide to take on additional risk by investing in more adventurous funds – funds that have the potential for attractive long-term returns.
Smart investors use tax wrappers such as ISAs and SIPPs to further boost their returns and pay less tax. Outperforming the market over the long-term may be extremely difficult to achieve. However, it is possible. When an investor is successful in ‘beating the market’, it helps them achieve higher returns and reduces the risk of running out of capital later in life.
Remember, if you would like to know more, please just download our free report The 7 Biggest Mistakes That Investors Make.
As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
ISACO specialises in ISA and SIPP Investment and is the pioneer of ‘Shadow Investment’; an easy way to grow your ISA and SIPP at low cost. Together with our clients, we have an estimated £57 million actively invested in ISAs and pensions*. Clients like us because we have a great track record of ‘beating’ the FTSE 100**. Over the last 16 years, we’ve outperformed the Footsie by 60.2% and over the last 5 years, we’ve averaged 14.5% each year versus the FTSE 100’s 8.8%. You can find us at www.ISACO.co.uk.
What is Shadow Investment?
Picking the right fund for your ISA and SIPP is not exactly the easiest job in the world. And knowing 'when' to buy and 'when' to exit is even more difficult! Our ‘Shadow Investment’ Service is here to help. Our service allows you to look over our shoulder and buy the same funds that we are buying.
When we are thinking of buying a fund, we alert you so that you have the opportunity to buy it on the same day that we buy it. We also tell you about when we are planning to exit the fund. You control your investment account, not us. You can start small and invest as little or as much money as you like.
By knowing what we are buying, when we are buying and when we are exiting, throughout the year you can mirror our movements and in effect replicate our trades. This means you have the opportunity to benefit from exactly the same investment returns that we get. Our investment aims are 10–12% per year.
We are totally independent, fully transparent and FCA compliant. We’re warm, friendly and highly responsive and it’s a very personal service that gives you direct access to the Sutherland brothers; ISACO’s two founders.
Who are ISACO’s clients?
Clients who benefit most from our service have over £250,000 actively invested and the majority of them are wealthy retirees, business owners, self-employed professionals and corporate executives. We also have clients from the financial services sector, such as IFAs and wealth managers.
Do you have questions?
To have all your questions answered, call 0800 170 7750 or email us at: info@ISACO.co.uk.
*November 15th 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
**Long-term performance: December 31st 1997 - December 31st 2013 ISACO 91.3%, FTSE 100 31.1%. 5 year performance: December 31st 2008 - December 31st 2013. ISACO Investment performance verified by Independent Executives Ltd.