Getting Started – Common Investing Mistakes

This post explores the common mistakes faced by traders and investors. I am putting together a series of posts in the Getting Started series to help new investors, but this post holds true for seasoned investors as well – as we tend to forget some of the basics and get caught in the moment. It is always important to keep track of the following points while investing in order to avoid repeating these mistakes.
1. Lack of understanding: Jumping into an investment without understanding it is one of the most common mistake. Every profession goes through years of training and practice, yet people gamble their life savings away by jumping into the stock market without educating themselves. Trading the hot stocks that you hear about without understanding  anything about the business is guaranteed to lose you money. Another problem adding fuel to the fire here is that the media and “experts” pass on their opinion portraying it as factual information.
2. Timing the market: Timing and beating the market consistently is probabilistically unlikely. Day trading and high-frequency trading simply does not work for the individual investor because the odds of beating the institutions are minimal, if not zero. Institutional investors always have more data (or at the very least, data before you do – which could even be by a fraction of a second), faster computers, better trading strategies which will always help them come out on top.
Remember that there are two parties to a trade. For every trade where you are buying and are sure that you are timing it right, there is another person who thinks that getting out at the moment is the best course of action. What one needs to consider is this: “What information does the other person have that I dont?”
3. Instincts and Emotions: Trading with instincts and emotions is one of the top reasons for the irrationality of the masses. Bringing emotion into your investing mechanism could result in huge losses. Investors should never get attached and fall in love with particular stocks and even your best performer should be a candidate for selling if something fundamental changes where the investment does not make any sense. 
4. Invest in what you know: ‘Invest in what you know’ has become a common theme in the investing world, which has also been perpetrated by the media. I disagree with this approach. Investing in a company just because you “know” their product doesn’t mean it can be a great investment. For example, I have heard many a times from gamers tending to think that a Xbox and PlayStation are fantastic products and are buying Microsoft and Sony are the way to go. However, during the life of Xbox 360, Microsoft was losing money on every console sold. Gaming has never been a breadwinner for Microsoft. Similarly, the Sony stock SNE has had a terrible run over years. Sony is a huge conglomerate, and even with its hands in so many pies, SNE has returned -17.5% in the past 5 years and -47% in the past 10 years.
Similar argument holds for geographical investments. Investors simply tend to stay invested in their own country instead of diversifying with investments in other countries.
5. Patience: Time is one of the biggest, if not the biggest factor in investing. An investment in a solid company which has a great business producing profits year-in-year-out will be your star performer. All you have to do is simply sit back and wait for your returns to compound over time.
6. Not sticking to the plan: Sometime also termed Performance chasing (although I dont like using that term for this issue) and shifting focus to the current theme that seems to make sense momentarily and abandoning your original plan to jump on the latest bandwagon – this approach can also incur losses in an investor’s portfolio.
7. Fees: Fees add up. A lot. If investments fees arent kept in check, returns can be diminished by thousands of dollars over a lifetime. It is for this reason that I discourage using mutual funds and instead use low cost index ETFs for better returns.

What do you think of the list above? Are there any other common mistakes that I have missed? Share your thoughts in the comments below.

Bond Allocation

Investing in bonds provides an investor with a diversified investment portfolio. Every investor’s portfolio should consist of some bond component. Bonds provide stability in the portfolio and a predictable income stream.

Asset Allocation

It has become a common advise from most advisors that the percentage of bonds in your portfolio should be ‘100 – your age’. This gives you a rough idea of the importance of bonds, but should not be followed as a hard written rule. Benjamin Graham, the father of value investing, gives a simple (and in my opinion, better) rule of thumb to follow. Relative allocation between stocks and bonds should be between 25% and 75%, one way or the other. He goes on to say “any such variations should be clearly based on value considerations, which would lead [the investor] to own more common stocks when the market seems low in relation to value and less…when the market seems high in relation to value”.

My Bond Allocation

Bond allocation in my portfolio in Aug 2013 is about 11% – a relatively low value. This is because of the historically low interest rates that we currently have. The chart below shows the US 10-year treasury yield. The yields are at their lows and are already starting to creep up. When bond yields rise, bond fund prices lose value, so I have decided to keep my bond allocation to what I consider minimal.
historical bond yields

I only hold high grade near term maturity bonds as of this writing. I hold bonds using the iShares 1-5 Yr Laddered Government Bond Fund (TSE: CLF) ETF, which is composed of Canadian federal and provincial bonds maturing between 1 and 5 years.

 
Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.
 

Impact of Interest Rates

Changes in interest rates can have a huge impact on your portfolio. With interest rates at historical lows (in US and Canada), it is only a matter of time before they start rising. This post discusses how the rise in interest rates affects each sector.

Rising Interest Rates

When interest rates rise, credit becomes more expensive and the equity market will tend to falter a bit as a first reaction, but as the economy improves, the equities will recover.

  • Bonds: Bonds are the most sensitive asset class to changes in interest rates. Bond prices fall effectively increasing the bond yields.
  • REIT: REITs fall (initially). REITs become an alternative for income investors during low interest periods. The more interest rates rise, the less REITs make because they have to pay higher borrowing costs. REITs may later perform well after the initial fall if inflation picks up – see ‘Inflation’ below for details. Click here to read more about impact of interest rates on REITs.
  • Financial sector: The financial sector will produce winners and losers. The banks that are well capitalized perform better than others. Banks with a heavy focus heavily on mortgages could benefit from the increased earnings from mortgage payments.
  • Energy infrastructure: This sector tends to fall. The increase of debt on the companies puts a downward pressure. Exceptions include companies with high growth potential or long term contracts.
  • Utilities: Utilities fall. When interest rates are low, bond investors turn to utilities as next-best alternative for yield. With rising interest rates, investor return to the safe haven of bonds driving stock prices in the utilities sector lower.
  • Inflation: One of the motivations for the central bank to rise interest rates is the threat of inflation. If inflation is high, sectors such as REITs, commodities (gold, oil), inflation-indexed bonds etc will do well after the initial jitter in the markets.
What are your thoughts on the impact of interest rates?
Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.

A Scam Called Mutual Fund

If there is any universal piece of advice in the investing world, it should be – “Stay away from mutual funds”.
Mutual funds come with a a little hidden number called MER – the Management Expense Ratio – which looks measly to begin with ranging from 1%-3% (some mutual funds may be as high as 5%).

Do not get fooled by this number because this number is a recurring annual fee and is taken off the overall returns of the fund, so you never see it anywhere on your semi-annual or annual statements reminding you that you just gave a major part of your savings to the fund company.

The Solution

  1. If you are looking for diversification without picking individual stocks, invest using an ETF – Exchange Traded Fund. The ETF fees normally vary from 0.05% to 0.8%. 
  2. A better option is to build your own portfolio. You pay a one time trading fee and no other recurring fees. You have two options – either direct investing via a DRIP plan or through an online discount broker.

Use Case

To best illustrate my point, lets assume you decided to invest in a mutual fund:

  • Initial investment: $10,000
  • Subsequent investments: None
  • Rate of investment return: 5%
  • Mutual fund MER = 2%  (which is a conservative estimate of the funds available in the market).
  • ETF MER = 0.5%
  • Stock investing via DRIP – assuming you buy 10 companies and setup direct investing – the only expense would be the cost associated with obtaining the first share from your peers (which is usually $10).
  • Stock investing via discount brokerage – assuming you buy 10 companies and a trading fee of $4.95 per trade (as offered by Questrade).
Mutual Fund Fees ETF Fees DRIP Investing Brokerage Fees
After 1 year $807 $52 $100 $49.50
After 5 years $1,444 $315 $100 $49.50
After 10 years $2,605 $796 $100 $49.50
After 20 years $6,849 $2,530 $100 $49.50

ETF fees also add up over time, but no where near the rate of mutual fund fees. So, if you are looking for diversification with a fund, it is no brainer to choose ETFs.
If keeping your fees down is your ultimate goal, direct investing either via DRIP or online discount broker is your best option.

If you own mutual funds and wish to find out how much your funds are costing you, click here for a great tool.

Disclosure: I owned about 6 mutual funds until I started realizing the snowballing effects of the fees. I have started trimming them down and currently own two mutual funds. I am hoping to cut back on those two funds in the near future.

Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.