Three things every investor must avoid

Three things every investor must avoid

The path to investment success is fraught with peril. It needn’t be this way, but along the road there are many traps for the unwary, and it seems that the natural state for we humans – at least when it comes to investments – is a certain level of unwariness.

With this in mind, we’ve set out below what we see as some of the main pitfalls along the way, and some thoughts on how you may avoid them. 

Pitfall #1: Not knowing the long-term objective

Any investment strategy should be built on a solid foundation of knowing what the strategy is meant to achieve. It’s hard to steer the ship if you don’t know your destination, and the critical element here is being realistic. Investing can certainly make you wealthy slowly.  For example, Elroy Dimson, Paul Marsh and Mike Staunton, academics from the London Business School, claim the Australian share market has, since the year 1900, delivered an average annual return of 11 per cent, and an average real annual return (after inflation) of 7.3 per cent.

Investors who lose sight of this are prone to take on too much risk trying to turbo-charge their short-term returns and this can manifest in excessive leverage, placing big bets on companies of dubious quality and/or trading too frequently. 

On the other hand, a clear view of what you are trying to achieve (and when) can give you the patience to avoid temptation.  Over long stretches of time, an average annual real 7.3 per cent is enough to achieve meaningful wealth accumulation, and if you can exceed this through wise investment selection without excessive risk then so much the better. However, if you neglect the long game and instead try to hit the ball out of the park today, there is a good chance the long run outcome will suffer.

Pitfall #2: Allowing emotion to take over

Q: What do most share investors feel when the stock market has risen strongly?

A: Happy!

Q: What should they feel?

A: Concerned.

It is a well-established fact that we typically form our views on the stock market with one eye in the rear view mirror. This is understandable, as the windscreen can be very cloudy. Research has shown that investors consistently pour money into the equity market when it has been rising, and take money out after it has fallen. The same research shows that this behaviour is devastating to long term returns because it means investors get the timing wrong.

If you have successfully negotiated pitfall #1 and are taking a patient approach to wealth creation, it will be easier to deal with pitfall #2. Taking a long-term view means not worrying about what return you got last year – or might get next year – but taking steps to ensure a good result on average over the long haul.

Taking advantage of the emotion of others in attempting to buy well and for the long haul generally assists.  Conversely those investors who can’t stand the pain during periods of higher volatility and insist on selling into “the lows” probably should avoid being in the share market altogether.

 Pitfall #3: Forgetting risk

Risk management is the forgotten, frumpy cousin of investment. It deserves more attention.

In the short term, taking on risk can lead to better investment returns, but in the long run, risk is risk and sooner or later its downside emerges. The best way to illustrate this may be to invoke the name of Babcock and Brown (ASX:BNB). Following a keenly-sought float in 2004, BNB shares rose from under $10 to more than $30 during the last bull market, generating steadily rising profits on the back of highly-leveraged investment structures. It all worked beautifully until the time that it stopped working, and the risk inherent in its levered structures wiped out equity holders completely.

Astute readers may have noticed that the three pitfalls identified above are all sides of the one (oddly-shaped) coin: patience. The share market offers twists and turns from year to year, but in the long run, it takes wealth from impatient investors and delivers it to patient investors. Those who sell shares at discounted prices in the midst of a crisis are planting the seeds of future wealth for those willing to wait for it; and those who chase spectacular returns may succeed for a time, but sooner or later most will get caught.

Patience is boring and does not make for racy investment stories, or front page newspaper articles, but if your goal is long-term wealth accumulation, there’s probably nothing that will get you there faster.

To learn more about our domestic and global funds, please click here, or contact me, David Buckland, on 02 8046 5000 or at dbuckland@montinvest.com.

MORE BY DavidINVEST WITH MONTGOMERY

Chief Executive Officer of Montgomery Investment Management, David Buckland has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.