Like any human activity, investing is prone to errors of human thinking and behaviour. How can these mistakes be avoided? While avoiding them completely may not be possible, simply being aware of the pitfalls we can create for ourselves by our own behaviour can make it less likely that we fall victim to them.
“I have made many mistakes over the course of my career as an investor. When I started Sifter Fund in 2003, I wanted to create a fund that minimises these human mistakes,” Hannes Kulvik says.
“The strategy and culture of Sifter Fund are built around a systematic process. That process helps us prevent human error,” Kulvik explains.
“Clear investment strategy and systematic process create peace of mind for myself and hopefully for the other investors in the fund as well.”
Hannes Kulvik lists the 10 biggest pitfalls for investors to avoid:
1. Believing in your ability to see the future
Most people who drive a car believe they are better drivers than average. Similarly, many people believe they are better than average at predicting what the share prices will be tomorrow or next week. Don’t think that. You aren’t.
2. Short-term investing
Success in short-term investing relies on luck and chance. Short-term investing has little to do with knowledge and company analysis.
3. Guessing share prices based on historical data
Technical analysis is worthless. Historical share prices are about as useful for judging the future of a company as your horoscope is for revealing what’s ahead for you.
4. The more complex the investment product, the higher the returns
Simplicity is efficient. Simplicity works. Bankers are eager to develop complex investment products that, at their worst, are little more than gambling instruments.
The rule of thumb is that the more complex the product is, the more money the banker will make and the less the investor will earn relative to the risk involved.
5. Lack of discipline
When you have devised a good investment strategy, it is often enough to just stick to it. In practice, many investors deviate from their strategy when the market conditions change. For example, after the markets have taken a dip, the risk appetite of investors tends to be at its lowest, even though that is the time when risk-taking is usually rewarded the most.
6. Trying to time the market
It’s not possible to guess when the market bottoms out (“now I’ll buy”) and tops out (“now I’ll sell”). Trying to do that will only erode your returns and fray your nerves.
Sadly, it is all too common that emotions and speculation replace systematic analysis. Investors buy and sell stocks based on their feelings.
8. Trading on rumours
If you have a good business in your portfolio, you shouldn’t sell those stocks just because someone spreads rumours about the company being in difficulties. Neither should you sell stocks simply because the share price goes down.
You need to monitor your investments so you can make a rational decision on when it’s time to divest.
9. Pitting asset managers against each other
Many investors pit asset managers against each other like racehorses. They divide their assets between five portfolios and, one year later, get rid of the two worst-performing asset managers and replace them with others. This approach does not produce good results.
Firstly, one year is much too short a period for assessing the performance of an asset manager. The results will be down to chance. Secondly, pitting asset managers against each other can create unhealthy incentives: towards the end of the period, the asset managers that are not performing well will have an incentive to turn things around by taking big risks — with your money.
10. Relying on tips from friends
If you make investment decisions based on tips from your friends — or, even worse, in your friend’s company — you often suffer a twofold loss: you lose money and you lose the friendship.
Even though most of these investment pitfalls are quite obvious, most of us are all too familiar with them. The cornerstones of Sifter Fund’s approach to investing are:
- Identifying high-quality companies by means of a systematic process that leaves no room for emotions and guesswork.
- Holding on to investments in high-quality companies for a long time and monitoring changes in their business.
- Keeping a cool head even when the stock markets fluctuate for various reasons.
Interested in long-term quality investing? Download our 20-page guide: Long-term quality investing. Our guide explains how time and high-quality companies work in an investor’s favor.
Founder of Sifter Fund and
Chairman of the Investment Advisory Committee
This article was first published in Finnish on 9 March 2020 on the website of Arvopaperi, Finland’s premier financial publication.