There are basic pitfalls that investors always face, no matter how long they've been in the game.peshkov/Getty Images/iStockphoto
Ryan Modesto, CFA, is CEO at 5i Research, a conflict-free investment research provider for retail investors offering research reports, model portfolios and investor Q&A. 5i Research provides content under an agreement with The Globe and Mail, which receives royalty compensation. Try it.
After running a stock simulation competition for high school students, we uncovered plenty of lessons that benefited young and old investors alike. So many, in fact, that we had to present them in two parts. You can read the first part here.
While the first lessons were a little more stock-specific (when to sell, understanding risks, etc.), this second list focuses more on behavioural investing. This is fitting, as while being able to manage your individual investments is important, being able to manage yourself and your interactions with your portfolio can often be the key to long-term success.
Diversification is key
Diversification is one of the fundamental principles of portfolio management, and our participants in the simulation were quick to learn this. Like every investor, some participants made some less-than-good investments, but diversification meant that they continued on relatively unscathed and able to invest another day. Diversification made the downs bearable while allowing other uncorrelated areas pick up the slack for the laggards. The ability to lower risk while maintaining the return potential in a portfolio is one of the few, if not only, free lunches in investing.
Keep your fees low
Some participants were aware of how fees and transaction costs can eat into returns, and this cost was a reason many shied away from short-term trading strategies. One of the return components an investor has absolute control over is that of costs. Reducing costs in the form of trading, fees, and taxes is one surefire way to ensure the returns of a portfolio are maximized, and it only becomes more valuable the earlier an investor realizes it. Much like how compounding returns can be significant over the long term, so too can the compounding impact of fees eating into your capital.
Don't check your stocks everyday
One of the things ends up working against many investors is the ability to check on holdings on a daily basis. Doing so makes an investor attempt to rationalize the moves daily and reconsider their initial thesis every time the stock moves in the opposite direction. Simply not checking in so often allowed some participants to trust their process and not question themselves quite so much, in turn leading to a reduction in the number of mistakes being made at the wrong time. Interestingly, there have been studies conducted that show the less active an investor is, the more successful they are, and some banks have even found that the best-performing client portfolios belong to the deceased and haven't been touched (or looked at) for years.
Lower risk equals lower returns (and that's ok)
One participant decided to ignore their peers and benchmarks and simply carry out a strategy that made sense for them. Interestingly enough, it ended up a top-ranked portfolio by the end of the competition. The lesson here is that while lower risk does mean lower returns, that is not a bad thing. What's important is that you, the end investor, are comfortable with the level of risk and return being achieved and that your specific short-term and long-term needs are being met. While understanding what peers and benchmarks are doing can be helpful, they don't necessarily speak to your own personal circumstances. What matters is that your needs are being met at a fair cost, not what returns your neighbours received.
Include an 'investing bucket' as part of your savings strategy
This is a lesson that gets missed by most in the investing and personal finance sphere, and even one that opened our own eyes a little. So often we hear about the importance of saving for a house and saving for a rainy day fund when individuals are starting out on their journey to financial independence. While these types of savings are important, very few talk about the importance of saving for investing as well. Especially at a young age, saving for investing can be one of the most important long-term factors in one's financial success, yet it always seems to take a backseat to things like a house. Just as an individual portions a bit of income off to a house fund and a rainy day fund, we think building an investing fund should be right up there in the list of priorities.
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