How to avoid the four most common investment mistakes
«Investing is simple but not easy» was once said by the greatest investor of all time, Warren Buffett. He meant that when it comes to investing, our human nature and psychology often get in the way. Many investors fall into the same psychological traps again and again and thus make costly mistakes. We don’t want the same thing to happen to you and therefore give you tips on how to avoid the typical investment mistakes.
Investment mistake no. 1: Not investing broadly enough
It often happens that investors concentrate on a few investments. They invest in shares of companies that convince them or that have risen strongly recently. Investment performance thus depends heavily on individual companies.
Diversification reduces risk
As early as 1952, Nobel Prize winner Harry Markowitz showed in a study that broad-based, i.e. highly diversified investments can reduce risk without generating lower returns. The reason for this is actually quite simple: every company and every industry is exposed to slightly different risks and those who invest broadly in different companies, industries and world regions benefit from the fact that these company-specific risks are partially balanced out. The Corona crisis, for example, hit the airlines and travel industry hard, while the e-commerce and technology companies were able to profit from it.
ETFs automatically offer smart bundling
So if you invest broadly, you can almost eliminate the risk of individual companies and thus reduce the overall risk when investing. For this reason, findependent’s investment solutions consist of several thousand individual securities from around 40 different countries, bundled via ETFs.
How ETFs work
ETFs («exchange traded funds») each cover an entire market, e.g. a bond, equity or real estate market. They are therefore proven investment instruments for building up a broad-based investment solution.
ETFs are based on an index, e.g. the Swiss Performance Index (SPI), which represents the Swiss equity market. The ETF pools the money of many investors and uses it to buy all the shares of the companies in the index. If, for example, you own a share in the “iShares SPI Core” ETF, you automatically own a small share of all the companies on the Swiss equity market.
Because you do not select individual investments but invest in an entire market, investing with ETFs is considered a passive investment strategy. Since ETFs basically track an index 1:1, they also achieve the same return as the index. This contrasts with actively managed funds, which attempt to achieve a higher return than the benchmark index by focusing on particularly promising investments. However, active management incurs many costs. For this reason, most active funds demonstrably fail to outperform the benchmark after deducting all costs, especially over the long term.
To cut to the chase: ETFs are inexpensive and make it possible to invest broadly even with little money. This makes it easier for beginners in particular to invest money with ETFs.
Investment mistake no. 2: Too many domestic investments
Many Swiss investors focus mainly on investments in Switzerland. This is simply because large Swiss companies such as Swatch or ABB are more familiar to us and we have a stronger relationship with them than with foreign companies. Swiss investments do have tax advantages and the exchange rate risk and any foreign currency fees are also eliminated. At the same time, however, a strong focus on domestic investments leads to a strong focus on the two sectors that are dominant in Switzerland: pharmaceuticals (keyword Roche and Novartis) and consumer staples (keyword Nestlé). Together, these account for almost 60% of the Swiss equity market. The situation is completely different in the USA, where the stock market is dominated by large tech companies such as Google, Microsoft and Apple.
Geographical distribution reduces risk
A global geographical spread of investments is therefore sensible in order to achieve good sector diversification. At findependent, the share allocation is therefore 40% Switzerland and 60% abroad.
Investment mistake no. 3: Too much actionism
Another typical investment mistake particularly affects those investors who regularly keep up with what is happening on the financial markets. They always want to be informed and react correctly to new events and developments. The problem with this is that the best reaction to most events is to do nothing. As a result, however, investors trade far too often, which leads to transaction costs with every purchase and sale. In keeping with the stock market adage “back and forth makes pockets empty”, these costs add up over time and lead to significant losses in returns. It is therefore not surprising that most private investors who trade on the stock exchange almost daily, so-called “day traders”, do not earn money with it, but lose it (NZZ, 2020, in German).
Hold investments for the long term (buy and hold)
Fluctuations are part of investing. It would therefore be a shame to be driven crazy by stock market fluctuations. In the long run, it is more promising to hold your investments beyond fluctuations and to pursue a so-called “buy and hold” strategy. This approach is also followed by findependent when investing in ETFs.
Investment mistake no. 4: Trying to hit the right time
All investors understandably want to get in and out of the stock market at the right times. The problem is that the development of the financial markets cannot be predicted. When trying to hit the right buying and selling times, most investors are always a little behind. They sell after prices have already fallen in a crisis and then miss the next upswing. In the long run, this leads to a strong loss of returns.
Developments on the stock market also do not always go hand in hand with developments in the real economy. Take the Corona crisis as a current example. Share prices fell sharply worldwide in the spring of 2020, but already recovered almost completely in the following months. However, those who did not invest their money until November 2020 in response to the first promising reports on vaccines have completely missed out on this sharp rise of more than 25% since mid-March.
Invest staggered
Instead of trying to hit the right moment, it is better to invest smaller amounts on a regular basis. That way you benefit from buying more shares when prices are low and fewer when prices are high. This effect, known as “dollar cost averaging”, automatically lowers the average purchase price.
The most convenient way to make staggered payments into your investment solution is to set up a standing order. This way you are not constantly confronted with the question of whether now might be a good time, and you outsmart yourself, so to speak. The same principle applies to sales: It’s best to withdraw your money in stages. Good to know: with findependent there are no additional costs for deposits and withdrawals.
Conclusion
All these mistakes have the same cause at their core. Investors behave too actively and want to react too much to any developments. This is understandable, especially because investing involves a lot of money. But this is precisely how we get in the way of our own investment success. It is emotionally difficult to keep one’s investments simple in all crisis and boom phases and to regularly invest smaller amounts regardless of the market situation. But it is precisely this passive behaviour that leads to success in the long run. Warren Buffet has also recognised this and advises investors to adopt a broad-based, passive investment strategy (CNBC, 2019).
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