| This is Money
Top five investment mistakes:
1. Over confidence
This is the most obvious error an investor can make. For evidence of the impact, you need only look at the recent sorry episode of the credit crunch. The greatest minds in the Square Mile and on Wall Street believed they had invented a new risk-free way of trading debt to generate colossal profits. It was, of course, total nonsense and taxpayers picked up the cost and global recession followed. But this over-confidence is not a new phenomenon. Countless financial disasters have occurred as a result of over-excited men in suits believing 'this time it's different'.
Over-confidence is prevalent. Blake points to research that asked FTSE 100 management teams to grade their performance; they all put themselves in the top 25%.
How it will affect you: Misplaced self-belief can wreak havoc with your portfolio. One example is that you will look at past investment calls and put a shrewd stock selection or fund exit timing down to your superior skills. It is more likely that you simply got lucky. Keep your achievements in perspective.
2. Doing too much
Goalkeepers are told that if they stand still for a penalty kick, statistically, they have a 33% chance of saving it; but only 6% stand still. Why? Because, egged on by the crowd, they can't be seen to be doing nothing.
IFAs want to be seen to be doing something. Small investors making their own calls can also fall victim to this 'activity bias'.
How it will affect you: The costly manifestation of this is trading too much and trying to call the market by entering and exiting too frequently. You can miss rallies and share dealing always incur charges, pushing up your overall costs.
3. Selling winning investments and holding losers
It is all too easy to forget your original reasons for investing and the promises you made to yourself about the risks you would take. It is the so-called 'loss aversion', a distortion that means investors are happy to take big risks when they face a loss but lose their nerve when they're in profit. Vanguard's Blake says: 'Clients become more risk averse when a stock rises and want to lock-in the gain, so they sell early.'
How it will affect you: This will take large chunks out of the potential profits, unless you control it. So how do you do that? Fight the compulsion to 'get back to break even' – veterans of the dotcom wipeout in the Noughties will tell that it may never happen. And keep sight of your original reasons for investing: do they still apply?
4. Home bias
Traditionally, IFAs recommended sticking it what you know best. So they encouraged investors to put most of your money into UK investments.
But the best performing emerging markets have left developed economies in the shade in recent years. And prospects for some of these economies are, arguably, far better than for our own: low government and consumer debts and favourable demographics in stark contrast to our own bulging borrowings and ageing population.
But remember that emerging markets have, historically, been volatile. You may also want to consider backing other developed market economies. Japan, for example, is sometimes suggested as an opportunity because its market trades very cheaply – although commentators have been predicting the sun to rise in Japan for more than a decade.
Behavioural finance warns investors to be aware of their own 'home bias'.
How it will affect you: The mainsteam advice was to hold at least 50% of your money in UK investments. That may be still right for some. The good news is that this isn't a sub-conscious decision. Most fund platforms offer a tool that will crunch your portfolio and show a geographical spread of your money. This will help you have a discussion with your adviser to at a sensible allocation that suits your attitude to risk. Blake says: 'Advisers should caution clients that familiarity is not a substitute for a good spread of investments.'
5. Other biases: 'Anchoring', 'familiarity' and more
A bias based on geography is not the only mistake you should watch out for. 'Anchoring' is investors linking decisions to irrelevant factors, such as round index levels: 'I'll sell when the FTSE 100 gets to 6000.'
A common mistake is to buy shares based on superficial evidence. An example would be to buy M&S shares because you like their clothes, but without drawing on any other information.
A similar error is to make knee-jerk decision based on scant evidence – known as 'availability evidence – such as selling Japanese investments immediately after the tsunami struck. 'Conservatism bias' can also creep in, where decision-making is based on out-dated wisdom and information. The solution is to keep on gathering and processing as much information as possible before making decisions.
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