A lot can go wrong when you’re deciding how to invest your money. Here we discuss 3 of the most common investment traps – and how to minimise the damage they can cause to your portfolio.
(There are a range of investment pitfalls that can destroy your wealth. You can read about them in a special report you can download here).
1. Regretting your buys
Once you’ve entered a buy order, it is common to be flooded with a range of emotions – excitement, pleasure, anxiety… or deep regret. “Did I just buy the right stock?” “Am I the sucker who just bought at the top of a market bubble?” “What if this company is a total lemon?” The same thing can happen when you buy anything that costs enough money that you feel it… from a refrigerator to a car.
All this worrying, or “buyer’s remorse,” can be damaging to more than just your health. Beating yourself up after buying something isn’t going to change the fact that you made the purchase. It could easily lead to an impulsive, emotional decision to sell a stock that could well turn out to be a terrific long-term investment.
What to do about it: Do your research before investing in anything, or buying something big. Understanding what you’re buying and why will help you avoid impulse buying and help reduce buyer’s remorse.
Also, when you decide what to buy and at what price, also decide when and at what price to sell it. Then set your stop-loss to prevent a monumental loss. That way you’ll avoid losing any sleep if the investment doesn’t work out how you’d hoped.
2. Doing what everyone else is doing
People tend to follow the herd. It’s human nature to think that if the majority is doing something, then it must be the right thing to do. But the reality is that there’s usually no good reason to follow others.
This crowd, or mob, mentality is one of the reasons market bubbles form. Everyone gets excited about a stock or an industry, the media starts talking about it and prices skyrocket. You don’t want to miss out, so you jump on the bandwagon just as prices are peaking.
It can work the other way, too. When a market starts to fall, the crowd sells everything because it’s worried about heavy losses. You panic and follow suit, guaranteeing your loss.
What to do about it: Listen to your parents’ advice – just because everyone else is doing it doesn’t mean it’s the right thing to do. Try to look at things objectively, and make up your own mind.
And try to be more of a contrarian. If everyone you know is talking stocks and the newspapers are publishing overly optimistic news, it may be time to consider the other side of the story. Or, if everything seems gloomy and everyone you know is avoiding the stock market, it might time to buy.
3. Assuming that someone else cares about your money as much as you do
Some of the most expensive words in the English language are, “My financial advisor [or private banker] is taking care of my money.”
Your financial advisor or private banker isn’t your friend. To him, you’re a big balloon full of money… and he’s trying to suck as much out of that balloon as possible. Many even have an acronym for it: SOW. This stands for “share of wallet” and refers to how much of your money they manage. They all want a higher SOW, so they manage more of your money… and earn more fees.
In many countries, advisors are governed by “suitability” rules, and not “fiduciary” rules. Suitability rules imply that if a client has a complaint about a bad investment, a financial advisor only needs to justify why he felt the investment he recommended was suitable for that client. However, the advisor has no legal obligation to do what’s in the best interest of the client. (Of course, he should be doing what’s in his clients’ best interests anyway… but it often doesn’t work out that way).
Having a fiduciary duty towards a client means the advisor has a legal obligation to do what’s best for the client – regardless of how much commission the decision earns (or costs) the advisor.
As we’ve written about before (and in more depth), advisors in Singapore and Hong Kong do not currently have a fiduciary duty towards clients (even though many clients assume they do). But earlier this year, the Monetary Authority of Singapore (MAS), Singapore’s financial regulator, did announce new rules to ensure advisors’ goals are more in line with their clients’ goals.
Hong Kong’s Securities and Futures Commission (SFC) also made some changes to their rules this year. As of the end of March, advisors have a contractual obligation to recommend suitable investments. What this means is that if the advisor is found to have recommended an unsuitable investment, he has broken the contract with the client. This means the advisor and his firm could be forced to pay back money to the client if found guilty.
This doesn’t mean that you should ignore what a financial advisor tells you. People who manage others’ money (should, and often do) know what they’re talking about. But they’re trying to make a living – and they’re doing it by providing a service to you.
What to do about it: Remember that the only person who has your best interests in mind is you. So ask questions. Read all the small print. Don’t be shy about asking for a cut in fees. Before you agree to anything, make sure you understand it. And remember that some advisors should be avoided altogether.
What legendary investor Peter Lynch said about stocks could also apply to any other financial instrument: “Invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator.”
Avoiding these three investment traps doesn’t mean every investment decision will turn out as planned. But it will help you avoid doing major damage to your investment portfolio.
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