As an investor I’ve made my fair share of mistakes — and learned from them. If I was to start investing today, here are six potentially costly mistakes I’d try to avoid making.
1. Not diversifying
No matter how great a company is, it should only ever be one part of a portfolio. A balanced, diversified portfolio is a simple but important form of risk management. It’s tempting to start investing by putting most or all of one’s funds into a single company. A lot of employees do this if they receive shares through an employer share scheme. No matter how good the results can be in any one situation, this is a high-risk strategy I would never use.
2. Over-emphasising management
There’s no doubt good management can boost a company’s performance. But if the only competitive advantage a business has is its management, that’s a risk. I always look for additional sources of competitive advantage, such as proprietary processes, strong brands, or entrenched distribution networks.
This is one potential mistake I’m bearing in mind when it comes to my position in S4 Capital. Its founder, Sir Martin Sorrell, is clearly talented. But it’s the team and ecosystem he is building around him that makes S4 investible for me, not just Sorrell’s involvement.
3. Focussing too much on history
Most investors who start investing look at a share’s historical data as it can be highly informative. What have its earnings been? Did its revenues grow? What is the historical dividend yield?
This is all useful information – but not in isolation. Past performance is not necessarily a guide to what will happen in the future. So I think it’s a mistake to focus too much on past performance rather than considering both historical performance and, more importantly, future outlook. It was that mistake that led me to purchase Shell only then to see it cut its dividend for the first time since the Second World War.
4. Not seeking alternative investment views
If I have a theory on a share, I’ll try and find out what other investors think about it too. It’s tempting to pay more attention to views which match mine and overlook opposing ones. It’s what behavioural psychologists call a ‘confirmation bias‘.
Every transaction on the stock exchange requires both a buyer and a seller. So it’s a mistake not to evaluate a share choice in terms of what could drive it down, as well as what could push it up.
5. Focussing on price not value
As investor Warren Buffett succinctly puts it, “price is what you pay, value is what you get”. In other words, a cheap share price doesn’t necessarily equate to a bargain – the share can still fall. It’s exactly that muddled thinking on price that led me to buy Centrica and my position remains underwater.
Instead, Buffett looks for high quality companies selling at what he regards as a fair price.
6. Trading too much
Trading has costs – financial, time, and sometimes emotional.
As a new investor, it’s tempting to jump in and out of positions in the excitement of stock trading. That is closer to speculation than investment. Many academic studies suggest that successful investors trade fairly infrequently. They prefer to select great stocks with fabulous long-term prospects then let time hopefully work its magic.
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Christopher Ruane owns shares in Centrica and S4 Capital. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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