Common Mistakes That DIY Investors Make

Investing

Common Mistakes That DIY Investors Make

Some investors opt to go it alone, thinking they can succeed without the help of a wealth management professional. Many soon discover that do-it-yourself (DIY) investing is fraught with dangers and difficulties.

Published on 15 January 2018

Stock prices in practically all the major markets across the world have been registering rapid gains in the recent past. The US benchmark S&P 500 Index has gone up by almost 20% in the past year and by 87% in the last five.

Tech stocks like Amazon, Apple, and Alphabet, Google’s parent company, have been rising even faster. If you had bought into the market several years ago and stayed invested through the boom, you would have made a handsome profit.

In a bull market like we have seen in recent years, investors can seemingly do no wrong. However, there is a downside to consistently rising share prices as this often gives investors the illusion that they have the “Midas touch” when it comes to their investment portfolios. They attribute their gains to their investing acumen, rather than the robust performance of the broader market. Furthermore, they become over-confident and complacent, expecting to make a profit on every purchase.

It’s important to remember, though, that making money in a bull market doesn’t make you an investment expert.

Do-it-yourself (DIY) investing ­– when you manage your portfolio by yourself without the help of a wealth management professional – can be a minefield.

Many investors opt to take the DIY route – and this is fraught with difficulties and dangers. As a DIY investor, there is a possibility that the strategy that you adopt could be fundamentally flawed, and the mistakes that you make could prove very expensive to rectify.

Here we take a look at some of the most common mistakes that DIY investors make.

Not diversifying your portfolio

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Don’t put all your eggs in one basket. This ancient adage is as true today as it ever was. If your entire investment portfolio is in stocks and the market crashes, you could suffer a devastating loss.

In early October 2007, the Dow Jones Industrial Average was trading above 14,000. Seventeen months later, on 6 March 2009, the Dow was at 6,595 – a drop of 50% in less than a year and a half. Remember that many individual stocks would have fallen by a greater percentage than the index.

In this same period of October 2007 to March 2009, gold prices went up from US$789 per troy ounce to US$916 ­– an increase of 16%. An investor who held a diversified portfolio that included gold in addition to stocks would have incurred lower losses.

Of course, gold is not the only diversification option. Your portfolio should include a rich variety of stocks, bonds, gold, and real estate.

Even your stock portfolio should not be restricted to only one industry or country. It should include shares of companies from at least three or four different sectors and various regions.

Not letting the profits run or cutting the losses

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Most DIY investors – and other investors as well – hate booking losses. If they buy a stock and it loses, say, 10% of its value, they refuse to sell in the hope that it will rebound. But, in many cases, the price falls even further. Indeed, DIY investors often avoid acknowledging that their investment decision has not turned out as they would have liked it to.

It is important to sell and cut your losses if the stock that you are holding is highly unlikely to increase in value anytime in the near future.

On the other hand, it is equally important to stay invested when an investment that you have made is increasing in value. Resist the urge to sell just because you have made a gain of 20% or 30% on your investment.

Amazon’s share price is a good example of this rule. In the last year, Amazon’s share has gained 49% in value. It’s currently trading at US$1,142 and has a Price-Earnings ratio (P/E Ratio) of 286.

Although the P/E ratio is at an astronomical level, 38 of the 47 analysts polled by CNN Money recently recommend that you buy the share at its current price. Another five classify it in the “outperform” category, signifying that they expect the share to perform better than the overall market. Only four analysts recommend that you “hold” the stock, expecting it to do as well as the market. The stock does not have even a single “sell’ recommendation.

Not taking the time to review your portfolio periodically

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Many DIY investors fail to devote time on a consistent basis to their investments.

When the market is doing well, your enthusiasm level is probably high and you will most likely check your portfolio periodically to see the gains piling up.

But at other times and especially when you are busy with other matters, you may not give your investments as much time and attention as you should. Ignoring the status of your portfolio for an extended period can be a mistake.

Here is why a periodic review is necessary:

  • Your financial position may be different – your priority could now be to generate income instead of capital appreciation, for example. This may require you to make changes in your holdings.
  • The market may have changed – a certain sector that you have invested in may be in a cyclical downturn. A review could reveal that it makes sense to sell.
  • Rebalancing between asset classes such as stocks, bonds, and commodities – the value of different investments could have changed. It may be time to rebalance your portfolio.

Thinking low-priced stocks are always a bargain

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DIY investors often make the mistake of assuming that falling prices always present a buying opportunity.

The recent performance of brick-and-mortar retailers demonstrates that it could be best to stay away from companies that have a failing business model. Indeed, Amazon’s rapid rise has resulted in traditional retailers closing stores and announcing layoffs.

Macy’s, a department store chain that traces its legacy back to 1858, has lost two-thirds of its market value in the last two years.

Similarly, JCPenny, another American department store giant, has seen its share price fall from US$35 at the beginning of 2012 to its current level of US$3.30.

An investor who had expected to take advantage of falling prices would have suffered significant losses instead.

The bottom line

Managing your investment portfolio can be a complicated affair. An issue that is very apparent to a professional may escape your attention. Getting guidance from a wealth management specialist can be even more important when the market goes into a downturn.

DIY investors often avoid seeking help from a professional financial advisor or wealth manager because they think that the fees for these services are expensive and could dilute their returns. What they don’t realise is that the advice that they receive from an expert can pay for itself many times over in the form of increased returns and a more resilient and stable investment portfolio.

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