It is a well known fact that average investors seriously underperform when investing. These average investors are those people that think investing is easy and do not put enough research into investing. Their lack of knowledge is their main detriment. But what exactly leads to them underperforming? Well this article gives 5 reasons as to why most people underperform.
with a bit of financial knowledge and thorough research, they will able to increase their performance levels.
1) Enter the market at the wrong time – The average person shows up when there has been a lot of news about how well an asset class has been doing. It could be stocks, housing, or any well-known asset. Typically the media trumpets the wisdom of those that previously invested, and suggests that there is more money to be made. In essence, they enter the market when asset prices are too expensive.
It can get as ridiculous as articles that suggest that everyone could be rich if they just bought the favored asset. Think for a moment. If holding the favored asset conferred wealth, why should anyone sell it to you?
Entering the market at the wrong time brings my mind back to the dot-com bubble. Most people did not get to the party early and only invested when the markets were at its top. By being late, they bought stocks once there prices had been bid up and lost everything when the markets crashed.
2) Leaving at the wrong time – If you left the market at or just after every crash, history has shown that you will will have missed out on any consequential gains. Leaving a market at the bottom seems highly irrational but this is exactly what most people do. Many sold out in 1987, 2002 and 2009 and stated that they would not touch stocks ever again and thus they have missed out on the bull markets that followed the crashes.
As Warren Buffet says, the aim is to buy low and sell high. Don’t let emotions get in the way ad don’t just flock into or out of the market just because everyone is doing it. Make sure you invest based on thorough research and sound valuations. And this brings up our next point.
3) Ignoring Valuations – The returns you get are a product of the difference in the entry and exit valuations, and the change in the value of the factor used to measure valuation, whether that is cash-flow from operations, earnings, free cash flow, EBITDA, book, sales etc. By having correct estimated future values, you are able to buy cheap now in order to maximize your returns.
Valuations are more than a stock market idea — it applies to private equity, purchase of capital assets in a business and even property investing. The cheaper you can source an asset, the better the ultimate return.
Ignoring valuations is most common with hot sectors or industries, and with growth stocks. The more you pay for the future, the harder it is to earn a strong return as the stock hopefully grows into the valuation.
4) Chasing the hot sector/industry – Greed and the lure of easy money often leads to emotional investing and this can often lead to catastrophic losses. This is because if you don’t get into hot sectors early enough, you will miss out on all the gains as the asset prices have already been bid up. By getting in late, you are just buying into a bubble as prices have already far exceeded valuations. Case in point tech stocks in 1987, dot-coms in 1999 or housing assets in 200.7
As Warren Buffet says, be fearful when others are greedy and greedy when others are fearful.
5) Not diversify enough – Diversification will lead you to getting a higher return for a given amount of risk. Having a diversified portfolio will mean that you will have to be diversified in many different sectors as well as asset classes. This means that investing in stocks and bonds is not good enough, you need to also be invested in property and precious metals such as gold and silver.
You need to also remember that diversification is inverse to knowledge. The more you genuinely know about an investment, the larger your positions can be. That said I make mistakes, as other people do. How much of a loss can you take on an individual investment before you feel crippled, and lose confidence in your abilities.
For people still at the early stages of their investing journey, it would be wise to have investment funds at the core of your portfolio. Whilst most funds are duds as they are dogged by high fees and their managers regularly underperform the market, they are a very select number of funds that are worth investing in as they regularly beat the market after fees. I have written an article on three such funds and you can see it here.