It’s a funny thing to think about, but millionaires are human beings, and like any human beings, they make mistakes. And, like us ordinary mortals, their mistakes are not limited to failing to get a pre-nup signed before walking down the aisle; they make investment mistakes too, just like we do. Of course, they have the money to recover from these mistakes, while we may not. So understanding their common mistakes and how to avoid them could help us manage our own finances better.
Luckily, this is something that’s quite easy to do. Recently, independent financial consultancy deVere Group conducted a survey of among their millionaire clients. The Group asked 880 clients what their number one investment mistake was, and then published the top five results. So, let’s take a look at these top five mistakes, and discuss how we can avoid them.
Mistake #1: Failing to adequately diversify
According to deVere Group, 23% of their high-net-worth clients said that their number one investment mistake was failing to diversify their investment holdings. Diversification is vital to building a successful investment portfolio because by diversifying into different asset classes and different geographic regions, you balance your risks.
How to avoid it: When you’re young, build a diversified portfolio focused on high-return assets – say 50% equities, 20% bonds, 20% property, 10% cash – and be sure to include an offshore component (split your equity and bond holdings between domestic and offshore at a ratio of 70/30, for example). When you’re older, remain diversified, but switch to capital protecting assets – say 40% bonds, 30% property, 20% equities, 10% cash – and retain your domestic/offshore split.
Mistake # 2: Investing without a plan
Fully 22% of deVere Groups clients said that their main mistake was investing without a plan. This seems like a no-brainer, but if rich folks are doing it, we’re probably doing it too. A plan is crucial to investment success; if you don’t know where you’re going, how will you get there?
How to avoid it: Decide what you need to save for, say, retirement, and how much you’ll need to save up for it. Then, work out how much you’ll need to save every month to achieve this, and what kind of return you’ll need to make on your investments. Work with a financial planner to figure out how best to achieve that return with a diversified portfolio, and then stick to your plan. Re-evaluate your plan regularly – perhaps twice a year – to make sure that you are getting the return you need, and to rebalance your portfolio because as prices rise and fall, you will have to tweak your holdings to keep your portfolio balanced.
Mistake # 3: Making emotional decisions
It’s so easy to do what 20% of deVere Group’s clients report doing: allow your emotions to dictate your investment decisions. Greed and fear are major drivers of investment behaviour, and it’s a very wise investor who can look beyond his or her emotional urges to make rational decisions.
How to avoid it: Having a plan will help you avoid this, but many people choose to hand their day-to-day money management over to a professional to ensure that their emotions won’t affect their returns. Simply talking through any investment decisions with a financial planner, a smart friend, or your partner can also help. Whenever you make an investment decision, take a few minutes to consider why you are making it. Do you have good, rational reasons, or are you panicked or greedy? Think first, then act.
Mistake # 4: Failing to regularly review your portfolio
Sixteen percent of deVere Group’s respondents listed failing to review their portfolio as their top mistake. As we’ve already discussed, regular portfolio review and rebalancing is a crucial part of good investment behaviour. Luckily, this is easy to avoid.
How to avoid it: Schedule annual or semi-annual portfolio reviews, where you sit down with a financial planner and your investment statements, and spend some time assessing your returns, rebalancing your asset split, and evaluating what you need to change.
Mistake # 5: Focusing too much on the history of an investment’s returns
This is a classic investment mistake, and one that 14% of deVere Group’s rich clients listed as their top mistake. We all know, intellectually, that past performance is no predictor of future performance. But when we analyse different investment opportunities, we still tend to spend a lot of time looking at historical performance charts and imagining that we will earn the same returns.
How to avoid it: Make historical review one small part of your investment analysis. Instead, spend time looking at future prospects, and evaluating what your returns will be like given the price of the asset. Read books on value investment like Ben Graham’s The Intelligent Investor, and train yourself to think about the future, and not just the past.