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One of the five sins investors make is keeping their losing stocks too long, after there has been a fundamental decline in the underlying company’s business.

SIphotography/iStockPhoto / Getty Images

When it comes to investing, Peter Hodson, former chairman of Sprott Asset Management LP, says there are five major mistakes people make that play havoc with their returns, chip away at their nest eggs and lead to plenty of sleepless nights.

“If I were to sum it up, keep your investments simple because more complexity usually means more fees. And be aware of conflicts of interest,” Mr. Hodson says.

A chartered financial analyst and a fellow of the Canadian Securities Institute, he managed funds with more than $1.1-billion in assets during his time at Sprott. After leaving that firm in 2011, he bought Canadian MoneySaver Magazine and founded the subscription-based independent investment research firm 5i Research Inc., where he is head of research. That service has answered thousands of questions – and the themes among them have shaped his list of sins.

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While Mr. Hodson believes that good advice from a financial advisor is well worth the money, some people prefer the “do-it-yourself” (DIY) route. But he says whichever way investors happen to go, the more involved they are with their financial affairs, the better off they will be.

“If you have an advisor and an investment plan that’s designed for you, it’s absolutely worth paying for,” he says. “DIY investing isn’t for everybody. It takes time and effort to manage a portfolio. So investors have to have an open mind toward risk and ask themselves what they would do if the stock market dropped by 5 or 10 per cent.”

Mr. Hodson shared his approach to investing and the five mistakes investors make in a recent interview with The Globe and Mail.

Why did you launch 5i Research?

I felt there was a need for a service that offers DIY investors conflict-free research and opinion. We only cover 70 mid-sized Canadian public companies. We don’t trade in anything we cover. We don’t have relationships with the companies we cover. We don’t manage any money. The only thing we offer is an opinion. We don’t tell you what to do, but we will tell you what we would do.

We give a basic rundown on financials, the management, the prospects and the risk.

So, who are your clients?

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We actually have plenty of investment advisors who use the service for ideas. We have wealthy clients who have abandoned the advisor model and are doing it on their own. We have a portion who do both.

Our average client has a net worth that is somewhat higher than average, but lower than what advisors view as a big client. If investors don’t have $400,000 or $500,000 in assets, advisors don’t give you much attention. But $350,000 is still a lot of money.

You say the first sin investors make is selling their winning stocks too soon. Why do they do that?

We get many questions from subscribers that ask whether they should sell a stock because it has gone up. But the fact that a stock is up is not a good reason to sell. You will never get a big winner like Alphabet Inc. (GOOGL-Q), Inc. (AMZN-Q) or Apple Inc. (AAPL-Q) if you sell too early.

The reason investors should sell is if there’s a change in the company’s prospects, to rebalance their portfolios or if they need the money.

Your second sin is that investors keep their losing stocks too long. But what exactly is too long?

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Too long means hanging on after there has been a fundamental decline in a business. That changes the thesis for owning its stock.

A recent example is Dorel Industries Inc. (DII-B-T). Dorel was a fabulous children’s furniture business. Then, it bought a couple of bicycle companies. The stock hasn’t done anything in 10 years and it was cut in half in the past month. If I had owned Dorel at the time it moved into bicycles, I would have asked why are they changing horses? What are the synergies between the two businesses?

Why is it so hard for investors to sell losing stocks?

People find it difficult to accept they’ve made a mistake. So, they say, “I’ll wait until it comes back and I break even.” Break even should not be a goal of any investor, but anyway, the odds of a company dwindling to nothing and coming back to where you bought it are almost zero. It doesn’t happen. Take the loss and buy something else.

Peter Hodson, founder and head of research, 5i Research Inc.

iStockPhoto / Getty Images

Your third sin is overdiversification. How many stocks is too many?

We have seen portfolios with more than 100 holdings, with each less than 1 per cent of the total. If you have a 1 per cent position, tripling it won’t move the needle. We think for the average investor, 20 to 25 stocks is enough. Have all the sectors represented. Diversify by sector and geography, large-cap and small-cap. Any differences are helpful.

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Sin number four is overestimating market risks. How does this hurt investors?

The odds of losing money in the stock market over the long term is minimal if investors invest in an index. Sure, if they invest for one year, they have pretty good odds of a loss. By three years, it shrinks dramatically. And after 15 years, historically, they can’t lose.

Bad news is better than good news for the media. So, the quarterly focus on earnings and whether the company is downgraded, or whether investors should rotate from value stocks into growth stocks are just noise for any investor who has a time horizon of 10 years or more.

The fifth sin is that fees eat up investors’ returns. What should investors watch out for?

When fees are compounded over time, they destroy performance. There are investment management fees, mutual fund fees and exchange-traded fund fees. They all add up. There are trading fees. The more you trade, the more fees and taxes you pay on profits.

Should investors be worried in the current climate?

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It’s usually the bullet you don’t expect that hits you. We aren’t worried about a recession and even if there is one, we don’t care that much. We have a longer-term view. And, of course, every crisis is a buying opportunity.

Adam Mayers is a contributing editor to the Internet Wealth Builder investment newsletter.

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