Being a successful investor is about more than picking the right stocks or funds. It's about avoiding bad habits that can sabotage your returns.
Based on letters from readers, conversations with investors and my own experience, I've compiled a list of some of the most common self-defeating behaviours. The more you can avoid them, the better off you and your portfolio will be in the long run.
How many of them apply to you?
Panicking when stocks fall
Market corrections, such as the 10-per-per-cent drop in the S&P/TSX since March 1, are an entirely normal part of the investing process, not a reason to pull your hair out. If you're still in the asset-accumulation phase of your life, you should be thrilled because a selloff provides an excellent opportunity to pick up good stocks at cheaper prices. Unloading stocks out of fear may provide relief initially, but it usually leads to regret when the market rebounds.
Chasing hot stocks and 'stories'
There is a widespread misconception that the way to make money in the market is to find a stock that is about to pop because of a takeover, new technology, favourable drill result or some other catalyst. These "can't miss" stocks rarely pan out as hoped, which is why smart investors shy away from them. Instead, they focus on boring, predictable companies whose profits, dividends and stock prices rise, not overnight, but gradually over many years.
Reaching for yield
I've lost count of the number of times someone has argued that a particular stock is superior to another solely because it has a higher yield. For dividend investors, yields should be like Goldilocks' favourite porridge – not too hot and not too cold. If a yield is too low, your income will be negligible. But if a yield is too high, it could signal trouble. Investors in AGF Management and TransAlta – to take two stocks that have plunged recently – learned about the perils of high yields the hard way.
Trading too much
If you're buying and selling frequently, the only certainty is that you'll pay more in commissions and taxes (if you're lucky enough to sell for a profit). A good portfolio requires very little maintenance, apart from occasional rebalancing to bring the equity and fixed-income components back to predetermined targets. Sure, you'll have to kick out the occasional dog, but the emphasis should be on trying to avoid these clunkers in the first place.
Gambling instead of investing
In recent days, otherwise intelligent people have been asking me with a straight face: "Is this a good time to buy RIM? I hear it may get taken over." This is not investing, people. It is speculating. You might as well take your money to the track and slap it down on the horse with the cutest name. At least you'll get to meet some interesting people at the track.
Paying exorbitant fees
You can build a perfectly good portfolio of index exchange-traded funds for an annual cost of 0.5 per cent or less. If you want active management, there are lots of fine mutual funds that charge 1.5 per cent or less. Yet many investors continue to buy mutual funds that charge 2.5 per cent or more, unaware of the serious drag this has on performance.
Buying things you don't understand
Remember this handy rule of thumb: The complexity of an investment is directly proportional to the misery it could cause you. If you don't understand something, don't buy it. Period. Be especially wary of any investment that a) is flogged at a seminar out by the airport, and/or b) seems too good to be true. It probably is.
Greed may be good for Gordon Gekko, but for small investors greed can be a killer. It's what leads them to try dangerous strategies such as borrowing to invest, buying leveraged ETFs and playing with options and other securities they don't fully understand. Successful investors realize that time and patience – not high-wire investment strategies – are their biggest allies.