Investing is a complex profession and is fraught with pitfalls for the unprepared. Sophisticated investors understand the complexity of managing long-term investments, and in doing so void the common pitfalls of the typical investor. Here are six of the most common mistakes made by typical investors.
A blind preference for particular asset classes
Investing in one or two asset classes such as property or shares is a common mistake. These investors are over-exposed to a substantial correction in property or share prices. Sophisticated investors have a deep understanding of all types of investments and investment concepts.
Not understanding how diversification works
One of the most common mistakes made by investors is believing that a balanced portfolio simply amounts to one-third cash, one-third property, and one-third shares. However, combining the low returns offered by cash with a high risk of growth assets does not produce good risk-adjusted returns over the long term. Sophisticated investors combine investments that area characteristically different so their portfolio will perform well under a wide range of economic conditions.
Expecting asset prices will continue to rise
Investors who rely too heavily on rising asset prices risk heavy losses in sliding economic conditions. Investors need to build in downside protection so their portfolio can perform well in both rising and falling markets and they are not reliant on rising asset prices.
Ignoring investment opportunities they aren’t familiar with
Many investors only understand cash, shares and property so they ignore other investment opportunities. Smart investors have access to a wider range of investments to choose from, including sophisticated hedge fund strategies, such as long-short and market neutral strategies.
Looking for the next big thing
Unsophisticated investors look for hot stock tips, and properties in ‘hot’ suburbs hoping to earn an unrealistic rate of return. Conversely, sophisticated investors add new investments to their portfolio only if an investment demonstrably improves their overall performance. They seek out investments with high levels of potential returns for the level of risk they carry.
Getting financial advice from family and friends
Listening to investment advice and tips at BBQ’s rather than seeking the counsel of professional advisers is a sure fire way to make investment mistakes.