Around this time, we tend to pay more attention to how our portfolios performed during the previous year. And for good reason: it's tax time, and we need to find out what we may owe in capital gains.
When analyzing your portfolio this year, keep in mind these eight mistakes that investors frequently make. They come from my experience both as a long-time investment adviser and as an investor myself. They raise important points that are good to keep in mind anytime during the year.
1. Investors tend to chase performance. We often think that because a stock or investment did really well in the past or is "high flying" now, that the trend will continue. This statement is often quoted in investment disclaimers: "Past performance is no indication of future results." It is very true and should be kept in mind when looking at any investment.
2. Lacking a sell discipline. It is often easier to make the decision to buy something rather than sell it. There are several ways to have a sell discipline. One is that you enter a "stop loss" order when you put in your buy order. The stop loss is an order that will sell out your position if the stock price drops to a pre-determined price. You can set that price at a point where, assuming you are losing money, you just don't want to absorb any more losses.
3. Quick to sell your winners and not your losers. This mistake is a bit of a continuation of mistake No. 2. It is easy to boast to your friends about a great stock pick that turned out well, but you are less likely to talk about the mistake you made that cost a lot of money. If you sell a loser, in a way you are admitting you made a mistake. As an adviser, it is definitely the more difficult call to make to one of my clients. But from experience, I have learned to push past that and make the call. There are so many unforeseen reasons that an investment can turn sour. But sometimes you need to get rid of the bad strawberry so it doesn't infect the others in the basket. If you continually sell your winning stocks, you eventually end up with a portfolio of losers.
4. Making investment decisions based on emotions. It is easy to get emotionally tied to a stock. That's especially so if you owned a stock that has gained considerably but more recently has been on the decline persistently. It can be difficult to sell. Some past examples: Nortel, Bre-X, and Blackberry. Keep in mind that investing in a company should be done with logic, not emotion. Adequate research should be done to substantiate the decision to make the investment; otherwise, it is like going to a racetrack and betting on the horse because you like the colour of the jockey's silks.
5. Dollar cost averaging down. This is a controversial mistake. There are many that believe that adding more shares to a losing investment to lower the cost is a good idea. Sometimes it is, and sometimes not. But I think in general it is often a mistake. If you wouldn't invest in the stock irrespective of whether you are averaging down or not, then it probably is not a good idea to do so. If the fundamentals and future outlook for the stock are positive and if you didn't already own shares, then it would make more sense.
6. Chasing fads. Just like there is a new trend colour announced every year, investment strategies can go through fads. There are the active trading strategies, day trading, the buy-and-hold strategy, ETFs, all mutual funds, only GICs, and many asset mix and balanced portfolio strategies. It is good to have a pre-determined strategy but be open minded to look for others if the market or economic conditions change and another strategy would be more appropriate. For example, if the market is going through a period of low volatility and low growth, it doesn't make sense to have a portfolio strategy of active trading.
7. Lack of patience. Now this is a really tough mistake that even a seasoned adviser like me can have difficulty with. We have all experienced making the decision to buy a stock and then watch it go down. I'm not talking about a significant drop but something that may drop a couple of percentage points. When this happens, it usually causes one to second guess an investment decision. The hardest thing to do is not to panic and sell. If you or your adviser has done adequate research to make the decision to buy, then stick to your decision for a reasonable amount of time (and that can vary depending on your objectives, risk tolerance and sell discipline) to let the investment show its true results.
8. Looking in the rear-view mirror. This is more of a state-of-mind mistake rather than an investment one. Knowledge of history is good. History can repeat itself but the important thing to know is not to dwell on it. Once things happen, especially negative things, it is not healthy for your mind or your investments to think, would've, should've, could've!
These are not the only mistakes investors make, nor am I immune from making choices that don't turn out as planned. The most important thing to know is to be informed or trust that someone is looking after your best interests. We are always looking for the holy grail of investing, but if you keep in mind that the goal is not to lose money and to make informed decisions, it can lessen the blows.
Nancy Woods is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. She is also the author of Globe Investor's Ask An Adviser series. You can send your questions to firstname.lastname@example.org. For an archive of her Q&As, please click here.