Top investment mistakes to avoid
Written and accurate as at: Feb 03, 2016 Current Stats & Facts
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Video: Morningstar's Christine St Anne and David Simon
Video Transcript
Christine St Anne: Market volatility will no doubt continue, and with that investors could be making some of the common mistakes of last year. To avoid these pitfalls, I'm joined by Westpac's David Simon.
David, welcome.
David Simon: Thank you.
St Anne: David, one of the common mistakes is staying out of market. What kind of investment opportunities are investors missing out on by doing that?
Simon: Yeah, sure. I mean, investors are naturally pessimistic and scared due to the current economic and political turmoil that is currently being witnessed in markets. Obviously, many investors tend to put off their decisions to invest days, months, and sometimes even years. Now this procrastination is one of investments - investors' most common mistakes, and it's obviously driven by fear of failure.
Now interestingly, there's some evidence to show that deferring or delaying investment decisions actually cause quite a significant opportunity cost, and one example, and the example is quite a significant one: if an investor choose to invest in the S&P 500 in March 2009, by the middle of November that year, they could have actually received a 51% return. Now, if the investor actually only deferred or procrastinated their decision by a period of only two months, that return would only be approximately half at 26% for that period.
St Anne: Investors are also continuing to favor cash. Are there any mistakes regarding diversification?
Simon: Yeah, diversification is a risk management technique that investors use to effectively ensure that their assets are, a range of asset classes and their investments, are not just in only one particular class, effectively not having all your eggs in one basket. Now cash is a certain and secure asset class. However, for an investor that only chooses to invest for a period for up to 3 years, that investment class may actually be the correct one. Nonetheless, cash has never been the best performer after inflation and tax for a period of 5 years or more. So, diversifying across a range of investment asset classes such as growth assets, as well as income assets may offer the opportunity for capital growth, and a better return than cash.
St Anne: David, with this market volatility, investors are also tempted to time the market. What are key pitfalls behind that?
Simon: Yeah. That's an interesting one. Certainly, some people that sold their shares before the global financial crisis have done very, very well, and considering that markets are still well below their pre-GFC levels, those investors are still smiling pretty. However, it's not often where investors that try to time the market actually get it right, and indeed investors that choose to time the market based on gut feel, speculation, and indeed without a strategy often fail.
Interestingly, recent data shows that if an investor invested in the Australian share market over the past 20 years, they'll have returned an average of around 7% per annum. However, if that same investor tried to time the market over that 20 year period, and missed out on the 20 best days during that period, their investment return would have reduced down to about 2.5% per year.
St Anne: David, investors tend to also chase numbers. What are the issues behind that especially in periods of market volatility?
Simon: Yeah, sure. Look, history has taught us that the normal and traditional asset classes such as shares, property, cash and bonds don't follow a normal or regular pattern. In fact, last year's best performer often becomes the following year's worst. Indeed over the last 20 years, for six out of the last 20 years, the previous best performing asset class actually did become the worst performing asset class a year thereafter. In fact, no single asset class has enjoyed any more than three consecutive years of being the best performing asset class over the last 20 years.
St Anne: David, thanks so much for your insights today.
Simon: Thank you.