1. Not shopping around for an advisor
It’s common for first-time investors to use the same advisor as their parent, friend, relative, etc. However, the advisor that’s right for someone else may not be right for you. Before you choose an advisor, consider your needs, the types of clients they work with, and how involved you want to be in your investing decisions.
Before you choose an advisor, ask these eight questions.
2. Not understanding how an investment works
Research investments before you make a decision. This is an important step because it ensures you:
- understand the risks associated with the investment, including the potential losses or returns;
- consider how it fits in your existing portfolio; and,
- know the fees you will pay and any penalties for early withdrawal.
Learn about different investment products – how they work, their risks, and whether they may be right for you.
3. Investing in something “trendy”
Some investments become popular through the media, through celebrity endorsements, or because they are new to the market. Friends may also recommend investments to you because they’ve chosen them for themselves. While it might be tempting and comforting to go along with decisions of a larger group, individual investors should be careful about participating in this sort of ‘herd behavior’.
Learn more about herd behaviour and ways to avoid it.
4. Not having a plan
Creating a plan will help you reach your financial goals. Set a regular time to review your investment plan, and ensure that if your financial goals (the reasons you are investing) have changed, your plan can change too. Having a plan will also help you choose your asset allocation for short- and long-term goals.
Your plan should be specific and realistic, and include information on your risk tolerance, investment strategy, asset allocation, and when and how your portfolio should be rebalanced. Learn more about creating an investment plan.
5. Not paying attention to fees
Understanding the fees you pay when you invest is important because they reduce your return. Ask questions before you invest and consider your options. For example, two investments may carry similar risk and expected return, but one may have higher fees – all else equal, the fees would affect your returns.
6. Being overconfident
Many investors overestimate their ability to “beat the market” by trading frequently, leaving them with lower returns than they would get by just holding a broad set of investments.
Our overconfidence can get compounded by the way we look at new information—we tend to look at this information in a way that confirms our prior beliefs. Thus, during a bull market when investments generally perform well, we might decide that it’s our trading decisions that are getting us higher returns. And during a bear market when investments perform poorly, we’ll blame the market, and hold onto our belief that we’re still good traders.
Learn more about overconfidence and how it can affect your ability to reach your financial goals.
7. Chasing performance
Past performance is not an indicator of future performance. This is a major lesson for new and experienced investors alike. If an investment did well last year, it may do poorly this year.
Focus on finding investments that fit well in your overall financial plan and that fit your risk level. See how chasing performance can affect your portfolio with this chart.
8. Not compounding returns
You can grow the money you save by investing it to earn a return. You can make your money grow faster if you also invest the money you earn (your return) along with the money you started out with. This is called compounding. Compounding works for both guaranteed and non-guaranteed investments.
Not reinvesting your returns can limit your ability to grow your savings faster and meet your financial goals when you want to. Learn more about growing your savings with compound interest.
9. Not reading account statements
You should receive monthly or quarterly account statements that show the activity in your account and provide an update on your investments. You may receive statements in the mail or you may be able to view them online. When you receive your account statements:
- Check that the investments bought and sold are correct.
- Check that the fees and commissions charged are correct.
- See how much your investments have gained or lost.
Contact your financial representative if anything in your account statements is unclear or seems incorrect.
10. Lack of diversification
Diversification (holding investments from a variety of different asset categories, industries, and geographies) can help reduce the overall risk in your portfolio. Here are some reasons to diversify:
- Not all types of investments perform well at the same time.
- Different types of investments are affected differently by world events and changes in economic factors such as interest rates, exchange rates and inflation rates.
- Diversification enables you to build a portfolio whose risk is smaller than the combined risks of the individual securities.
If your portfolio is not diversified, it will be unnecessarily risky. You will not earn a higher average return for accepting the unnecessary risk.