Four Ways Investors Go Wrong

09/28/2010 12:00 pm EST

Focus: MARKETS

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Gordon Pape, editor of the Canada Report, cites four big mistakes investors make—either south or north of the border—and tells what they should do instead.

If you are one of those people who suffered heavy losses over the past decade, it was most likely due to one of the following four reasons:

1.   Bad market timing. I fear that too often investors attempt to time the markets, which is extremely difficult even for professional money managers.

As I have pointed out many times over the years, it is one thing to identify trends but quite another to pinpoint when they will result in major market turns. Sometimes, the time lag can be many months or even years. Being on the wrong side of the market during that period can prove to be very costly.

2.   Aggressive asset allocation. Although it has been repeatedly proven to be the most important single factor in investment performance, many investors fail to use the principles of asset allocation in constructing their portfolios. This frequently results in a higher level of risk than is appropriate [because investors tend to] overweight stocks and/or equity mutual funds and underweight fixed-income securities.

I have seen many cases where people in their sixties and seventies had equity weightings of more than 75% and then were stunned when they lost a lot of money in the market bust of 2008-09. For most people, a disciplined asset-allocation approach is the first step to successful investing.

3.   Flawed advice. I just read another study purporting to show that Canadians who use financial advisors are better off than those who don't. This one came from the Investment Funds Institute of Canada (IFIC), most of whose products are sold by advisors.

[According to the report,] households with an advisor had 68% of their money in "market-sensitive" securities (equities and mutual funds) and 32% in "conservative" vehicles (term deposits, savings accounts, bonds).

Those who did not use an advisor were split almost equally—51% market-sensitive to 49% conservative. I suspect that a similar US study would produce comparable results.

Financial advisors, like all other professionals, aren't perfect. Sometimes the guidance they offer simply isn’t appropriate, either because it is inconsistent with a person's objectives and risk tolerance or because it is motivated at least in part by commissions. So, it is always a good idea to ask questions and be sure you understand exactly what you're buying before taking the plunge.

4.   Pure speculation. Some people like to gamble, pure and simple. I have always said that the place for that is a casino, not the stock market, but there are investors who can't resist. Occasionally, they make a big score. More often, they lose their stake.

Successful long-term investing requires patience and discipline. That may not seem exciting, but it will pay off over time and you won't end up sending me e-mails bemoaning your losses.

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