The three most common mistakes

By November 30, 2021 Financial Planning
Common mistakes

After almost 20 years of interacting with investors (and potential investors) on a daily basis, I’ve noticed some common themes that prevent investors from achieving their potential. If you can avoid all three, you are almost guaranteed to achieve financial security.

Whilst some of these matters seem relatively simple, you should not let their simplicity fool you into thinking that they are anything less than critical.   

Why do we tend to overcomplicate matters?

I believe that investing is simple. If you adopt a rules and evidence-based approach towards making investment decisions, it is virtually impossible to make a mistake. Successful investing is rooted in sound logic and basic math. There is nothing overly complex about it that cannot be explained in simple terms. That is why I wrote Investopoly – to outline 8 time-tested rules that if followed, would guarantee investors avoid making costly mistakes. I apologise if that sounds like a sales spiel. And I appreciate it sounds like a big promise. But I stand by it.

If investing is simple, why do people over-complicate it? Of course, the reason depends on the individual. However, I think there are probably two reasons.

Firstly, there is a lot at stake i.e. my family’s financial security, our dreams and goals. Given what’s at stake, people can have the tendency to over-think it due to fear of making a mistake.

Secondly, to many people, investing seems complex. Humans tend to think that complex problems require complex solutions. The truth is, simple solutions tend to be very effective, exhibit lower risk, lower cost, easy to implement and easy to understand.

Most mistakes are made by over-complicating financial decisions than over-simplifying them.

Investment mistake # 1: try to work it all out themselves

As a rule, I don’t perform my own dental work. I go to a dentist. When buying a property, I don’t do the conveyancing myself. I engage a professional and experienced lawyer. I don’t service my car… you get the point.

I rely on various professionals when (1) the consequences of making a mistake are unacceptable and (2) I don’t have enough knowledge and experience to give me a high level of confidence that I will not make any mistakes.

It has always puzzled me why someone would invest more than $1 million of borrowed money (e.g. buy an investment property) without getting any professional advice. Firstly, $1 million is a lot of money and the relative performance (e.g. 1% p.a. more) of the asset over 10+ years can make a huge difference in dollar terms (which I previously demonstrated here).

Secondly, you are investing money that’s not yours i.e. borrowed money. It’s not yours to lose. And it comes at a cost (interest rate) – and that cost is guaranteed – you must pay it regardless. Therefore, if you are on the hook for the cost of debt, you should take all possible steps to minimise the risk of under-performance. If you are not prepared to do that, then perhaps you shouldn’t be borrowing to invest.

Investment mistake # 2: to reduce risk, aim for a quick profit  

For almost 20 years I have written ad nauseam that ‘playing the long game’ gives you the greatest chance of successfully building wealth. That is, make investment/financial decisions that are focused solely on maximising outcomes in 10+ years’ time. This allows you to drown out all the (media) noise and focus on sound fundamentals. Fundamentals, not noise (rhetoric), drive investment returns in the long run.

However, the main challenge with playing the long game is delayed gratification. Take property as a good example. It is likely that you will need to hang onto a property for 10 to 20 years before you make a decent return in dollar terms (as this chart demonstrates eloquently). That is a long time for you to maintain faith and confidence in your investment decisions.  

But for many people, this approach feels risky. Generating immediate investment returns gives them the confidence that they are making progress. As such, they start to consider investment methodologies, products and strategies that aim to make quick returns. Examples include picking individual stocks that are predicted to take off, investing in property in an unproven location that is predicted to boom, buying a compromised property just because it has redevelopment potential and so forth.

Starbucks founder, Howard Schultz said it best; “short term profit never creates long term value”. Investors must forget about short term investments/returns. Even if you are successful in the short term, you need to find the next investment opportunity and never make any mistakes. Instead, it is much better to invest in assets that provide compounding returns over many decades, as I’ve discussed here.  

The trick with investing is to have patience. Investors with the most patience are rewarded in the long run.

Investment mistake # 3: don’t appreciate the urgency

In the mid-1700’s English poet, Edward Young wrote that “procrastination is the thief of time”. When it comes to building wealth, procrastination is the thief of wealth.

Mathematically, the longer you have to build wealth, the lower the rate of return you need.

For example, if you invest $100,000 when you are 25 and receive an average return of 5% p.a., your investment will be worth more than $700,000 by the time you are 65. However, if you don’t invest that $100,000 until you are 55 years of age, you need to generate a return of 22.5% p.a. for your investment to be worth $700,000 by age 65.

You do not have to accept much risk to generate a return of 5% p.a. over 40 years. However, you must take unacceptably high risk if you want to achieve a return of over 20% p.a. over a 10-year period.

Therefore, the longer you delay investing (procrastinate), you either must take more risk in the future or come to terms with accumulating less wealth. That is simple math.

I’m not suggesting that your sense of urgency needs to be at emergency levels. There is never a good reason to rush into an investment. Take your time. Be diligent. Get advice. Invest carefully. But you must avoid procrastinating. Because before you know it, many years will pass by, and the opportunity cost of that wasted time can be significant.

Simple mistakes are simple to avoid

These three common mistakes are not ground-breaking and might seem quite innocuous. But the reality is that they are incredibly insidious and can cost people dearly.

The good news is that these common mistakes are very easy to avoid. It’s worth investing a few minutes to reflect on your own situation. Have you made any of these mistakes in the past and if so, what steps can you take to avoid repeating them in the future?