Six Most Common Investment Blunders

Investing your hard earned cash is not a simple matter. Many things must be factored in before deciding on where to best invest your capital. Before taking risks, it would be beneficial to know the most common mistakes that investors make. Knowing what to avoid means that half the battle is won.

In looking for the most helpful advice, I appraised dozens of investment mistakes with a view to selecting those that have the most impact. I believe the short list below will prevent many people from economic suicide.

1. Thinking that past returns of an investment is an accurate predictor of future performance. Perhaps this one is the hardest to figure out. Even the wisest and most educated fall prey to this wrong reasoning. It seems logical to assume that an investment that made great returns in the preceding years would most probably continue being a good investment. Unfortunately, this seemingly scientific reasoning does not generally apply to investments because of two things: one, the value of the good investment is already incorporated in the price of the asset; and two, the performance of the investment may have been due to sheer luck. After all, there will always be a few investments that will outperform the market. Whether this is due to nothing more than luck is hard to tell.

2. Putting everything in one basket. No matter how solid an investment is, there is always the possibility that it may fail. Diversifying is the best way to avoid total disasters. But it is not as simple as it seems. People think that as long as there is a difference in the kind of investment, there is diversification. For there to be true diversification, it must first be from different types of assets; and second, there must be negative or no correlation between the asset types. This means that a change in the value of one asset class should result in an opposite reaction in the value of the other type of asset. For example, a depression usually reduces the stock price of companies with non-essential product lines and boosts the value of firms that deal with budget items.

3. Mistaking a business for an investment. An investment must not consume a significant amount of your time. Too many people with full-time day jobs put their capital on a business when they should have chosen an investment instead. A common mistake is buying a franchise thinking that it would run itself with minimal supervision. This is rarely the case because a franchise is a business. In the case of real estate, which is the most favoured investment, a small apartment with a few units is an investment; but a large boarding house with hundreds of boarders is definitely a business that demands constant attention. Mistaking a business for an investment may lead to losses, as you may not have the time or expertise to manage the business.

4. Not considering your investment horizon. The investment horizon is the length of time you expect not to liquidate the investment. Even the best investment in terms of returns would be useless if you cannot have access to the fund when you need it. This blunder usually happens when investing in the stock market. Although in the long run investing in stocks should be more profitable if done right, values fluctuate and you must be prepared to wait for years or be forced to liquidate at a loss. I suggest having a minimum of 10 years as your investment horizon if you plan to deal with stocks. Real estate investments are even less liquid and you may lose up to 50 percent of the value if you sell immediately. Study both your short-term and long-term needs and select an investment that can be withdrawn without substantial losses when you need it.

5. Not factoring in the effects of inflation. Very often you encounter a presentation where a small investment grows enormous after a few decades even with just a small interest rate. Unfortunately, if you consider inflation, the value added in real terms is substantially less. When setting your financial objectives, do not forget to consider the effects of inflation. For example, the college tuition fund you are saving for your children may be insufficient if you had not given a wide allowance for the high probability that it will cost much higher in the future.

6. Being greedy. Almost all scams use greed as the primary bait. As the old saying goes, “if it looks too good to be true, then it probably is!” What reels in the victim is that they see someone whom they trust make incredibly large amounts of money from an investment. Unfortunately, this is usually a Ponzi scheme where money from new investors is used to pay the interest and withdrawals of previous investors. Perhaps the only notable exception to this, although on a much lesser scale, is when banks, whose deposits are insured by the PDIC, offer high interest rates. However, this is applicable only if your deposit does not exceed the amount that is insured.

*Originally published by the Manila Bulletin. Written by Ruben Anlacan, Jr. (President, BusinessCoach, Inc.) All rights reserved. May not be reproduced or copied without express written permission of the copyright holders.