When investment habits affect optimal wealth growth
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September 12, 2021
Your investments have increased, how about your net worth?
September 14, 2021
Some investment habits can be detrimental to your financial health, preventing you from growing wealth optimally
Over the course of the Movement Control Order in Malaysia, brought about by the global Covid-19 pandemic, the lives of every individual in the country have been upended in more ways than one.
Changes to our daily routine that we would not have imagined half a year ago have become part and parcel of the “new normal” and almost second nature by now: wearing a mask in public spaces, having a bottle of hand sanitizer available on hand anywhere we go or constantly keeping a social distance from friends and colleagues.
Apart from adopting new habits, a silver lining has emerged where some have ended up discarding unhealthy habits such as late-night suppers, smoking or regularly eating out. Had it not been for circumstances forcing a change in lifestyle, many individuals would probably carry on less than ideal practices without giving much thought to them.
Likewise, when it comes to making investments, many individuals may not realise that some of their investment habits are actually detrimental to their financial health and can impede their ability to grow their wealth optimally.
It is important that these “unhealthy” investment habits are recognised so that they can be addressed in a timely manner to avoid long term repercussions. These are some of the most common habits that we observe among many investors:
#1 Investing TOO safely
Many people particularly retirees may prefer to play safe by putting all their money in fixed deposits (FD) alone because it is deemed to be the safest form of investment. However, in the current market environment where FD rates are below 3%, the impact of inflation is very apparent.
The Rule of 72 states that when you take 72 and divide it by the rate of return, the answer will tell you the number of years required to double your money. So, if you are getting a 3% return, it will take you 24 years to double your money!
With inflation eating into your money, your purchasing power 24 years later is going to be a lot less than today. In comparison, if you can navigate through a moderate risk diversified investment portfolio and earn an 8% annualised return, it would only take nine years to double your money.
#2 Emotional investing
Some investors tend to wait for the “right time” to invest, anticipating a feel-good factor when markets go up and this is when they decide to ride the wave of the moment in hopes of buying high to sell even higher.
In contrast, when the markets come down, they stay on the side- lines and play the waiting game, using negative market sentiment as justification for inaction when instead they should be taking the opportunity to bargain hunt. This is contrary to the investment philosophy of “buy low, sell high”.
#3 Following the crowd (FOMO: fear of missing out) mentality
When it comes to investing, word of mouth among friends and relatives is a common approach. Often what you hear are the good things informed to them by the salesperson and passed on without verification of facts or supporting evidence.
Victims of investment scams are commonly “recruited” into it by people they know and trust. It usually starts off innocently enough with a nominal amount put in for the sake of maintaining a cordial relationship with the so-called referrer and also out of curiosity to see how the scheme pans out.
However, small losses can add up over time and the opportunity cost of missing out on bona fide investments is time permanently lost.
#4 Misplaced sense of confidence
This is when an investor applies knowledge garnered from certain investment exposure as THE investment strategy for all investment asset classes, not realising that expertise in one area does not necessarily translate to identical outcomes in other areas as far as investments are concerned.
For example, a share trader who is used to high frequency trading activities decides to apply the same investment strategy in diversified investments such as unit trust, but the experience might turn out to be entirely different. As a result, he decides to stick to investments which allow active trading like forex or crypto currency investing since high frequency trading is his forte.
#5 Not investing based on the best of breed investments
This is quite typical of investors who, perhaps due to lack of time to do the necessary research, tend to invest with a blinkered approach instead of comparing the best investments in the target category.
In other words, are you considering all the available options for the similar type of product to compare, or are you limited to only one or two options as presented by the salesperson?
For example, an individual who wishes to invest in Malaysian small capitalised stocks should comb through the performance of various funds in the same category before arriving at a decision. Thereafter, this process should be repeated periodically to ensure that he remains in the best funds within the same category.
#6 Investing without a strategic asset allocation in mind
All investments can be loosely categorised as low, moderate or high risk. This categorisation is a function of the inherent price volatility of the investments. When one invests, it is important to understand the appropriate percentage or allocation of low, moderate and high risks assets and this is dependent on one’s risk profile.
As an example, the strategic asset allocation of a moderate risk investor should be around 10% of investable assets in low risk assets, 70-80% in moderate risk assets and the remaining 10-20% in high risk assets.
Low risk assets will comprise of assets such as bank deposits, capital protected investments or investment grade bonds. Moderate risk assets consist of investments such as balanced diversified portfolios, high dividend yielding shares, property investments or REITs. Lastly, high risk assets would encompass highly volatile assets such as growth focused or small cap stocks and alternative assets such as crypto currencies.
Very often, we come across those who invest a very high allocation (>70%) of their investable funds in their favourite assets, either properties or shares or plain old fixed deposits.
While it is not wrong to invest in instruments you are familiar with, choosing these over your ideal strategic asset allocation could result in an over exposure in certain asset classes that can leave you vulnerable during in a down market cycle of that asset class, or having to deal with very low yields as is the current scenario for FD investors.
#7 No active performance management
Another habitual tendency of investors is investing – full stop. What this means is once they put their money in an investment product, it’s hands-off from thereon. Active performance management is important because it allows:
• Tracking the performance of the investment and taking profit when there’s an opportunity;
• Reinvesting profit when the market goes down to average down your cost;
• Rebalancing your investment portfolio with a target asset allocation in mind; and
• Restructuring in order to move from an under-performing fund to a better performing fund in the same category.
Without active performance management, investors may miss out on time sensitive opportunities to better their investment returns.
In conclusion, while unhealthy investment habits may not bankrupt you overnight, they can potentially pose a large stumbling block to your wealth accumulation in the long run. In the current economic situation, most of us would agree that every ringgit counts.
Replacing these habits with new, healthier investment practices only requires some willpower and determination and the rest will follow suit.
First published in Smart Investor 07/08, 2020 Issue
Felix Neoh
Director of Financial Planning at Finwealth Management Sdn Bhd
