Tuesday, August 4, 2015

7 Deadly Sins of Investing (Guest Post)

7 deadly sins of investing
While a financial adviser usually won’t steer you wrong, it’s a good idea to know the more dangerous aspects of investing. And if you intend to do this on your own, you’ll need a smart, sharp lookout system to keep your portfolio safe. 

Here are the common pitfalls to look for:

1. Mistaking Trading for Investing

In the equities market, you can make money either by investing (buying shares and holding on to them for dividends), or by trading (trying to buy low and sell high).

Trading should not be considered the same as investing. It is a high risk activity that can result in capital losses, and you should be aware that no guaranteed trading system exists (or else everyone would never have to work again!)

A passive investment such as an Exchange Traded Fund (ETF) outperforms active traders 70% of the time, so a layperson is better off buying those and collecting dividends.

2. Investing Without Diversifying

Diversification is the process of buying lowly correlated assets, to avoid your entire portfolio being affected by a single downturn.

For example, say you buy shares in a gold ETF, buy physical gold, and then invest in a gold mining company and a jewellery company. These are all highly correlated assets. Had you held such a portfolio in July 2015 (during the gold flash crash), your entire portfolio would have taken a massive loss.

When the price of gold comes down, your physical gold will be devalued, the jewellery company will earn less, the gold mining company may no longer be profitable, etc.

For this reason, you need to purchase assets that are not too closely intertwined. A common method is to divide assets between sectors listed by the Global Industry Classification Standard (GICS). These range from consumer staples to telecommunications, and a balanced portfolio will have some assets in each separate sector.

If you do not understand how to diversify, and do not want to pay a wealth manager, you can consider buying an index fund like the ST Index. This will effectively diversify your assets across 30 blue chip companies.

3. Investing Your Time Instead of Your Money

It’s said that the rich buy time, and the poor sell it.

Make no mistake: time is not money, because time is more valuable than money. The whole point of money is to escape a nine to five job, and have spades of time to do whatever we want.

Think about that when you are offered a chance to work for equity in a startup, or when you are asked to “invest” your time in a scheme like multi-level marketing. It can be beneficial to work for free, but you must do so strategically and with a clear goal.

When will you see the rewards, and are they worth your time? When will you decide to walk away if things aren’t working? Never refuse to cut your losses, just because you’ve already “put too much effort” into a failed investment. 

4. Doubling Down on Something that Worked

If something works the first time, a common reaction is to “double down” and put even more money into it. This is a common fallacy that results in dramatic losses.

Past performance is not an indicator of future performance. The best performing business from 10 years ago may be obsolete by now, and face only declining revenues in the future (bubble tea shops are a prime example, as is Nokia).

Have a plan and stick to it, don’t divert all your money into a performance in the hopes of repetition. Do have a conversation with your financial adviser about rebalancing your portfolio, as this is a vital concern in formulaic rebalancing.

5. Investing in What You Don’t Know

If you are thinking of selling shoes, it would make sense to research the market for shoes before starting. You wouldn’t spend thousands of dollars to buy the shoes first, and then cross your fingers and hope they sell.

The same goes for investing. Never invest in any asset that you do not understand inside-out. Examples are buying mutual funds when you don’t know what the fund contains, or investing in a business without understanding the product (what if your friend’s software company, which you invested in, starts marketing a product that shortly after is labelled spyware?)

If you don’t know how it works, don’t bet your money on it. It’s that simple.

6. Investing with “Free” Services

Many investment services, particularly algorithms, claim to be free. They will only take a cut when you make a winning trade, for example, and charge nothing else.

These products can wipe out your investment portfolio in a matter of days.

Most “free” products focus on churning, making large numbers of trades (see point 1 about trading) in order to raise the odds of making a few successful trades. The person providing the service does not care if just one in ten trades is successful – she gets her money for her “free” service, and you bear the losses of the bad trades.

If it sounds too good to be true, it usually is.

7. Investing Without Saving

Never put your money into long term investments when you have no savings. You will likely incur losses.

For example, say you put $10,000 into the stock market, with a fairly safe ETF that gives you 5% returns per annum. This is not a bad deal, and many people have built retirement funds that way. However, you have no money in your savings.

You then get into an accident, for which you urgently need money. All your cash is in your ETF, so you will have to sell some units to raise cash. However, at the particular time you need it, the ETF’s price has fallen (not normally a concern to long term investors). If you are forced to sell at this time to raise cash, you will sell at a loss.

If the money had been in a fixed deposit at the bank, you would have lost all the accrued interest from withdrawing it. If it was a mutual fund, you may have been faced with stiff penalties.

So always ensure you have sufficient savings before making an investment. 

Alternatively, if you are in dire need of funds then consider a low interest personal loan instead of cashing out. You can find the cheapest personal loan using our loan calculator.

This article is contributed by Allyson of Singsaver.com.sg

Looking at the concept of INVESTING in a different way!

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