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Top 5 financial planning mistakes

19 January 2012 by National Bank
financial planning mistakes

When analyzing the behaviour of investors, whether novice or experienced, they tend to consistently make the same mistakes. Here are five of the more common ones and a few tips on how to avoid them.

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Certain investment behaviours are very common. The same mistakes seem to crop up, even if they result in losses. To find out how to avoid these traps, keep reading!

Believing the stock market will take care of your retirement

Many investors put their money into the stock market, expecting some kind of miracle. They hope high yielding stocks will provide a comfortable income and make up for their late retirement planning.

Tip: “People don’t understand that it’s not the market that will guarantee them a nest egg, but rather good financial habits. Even if you bring in a good salary, you need to control your spending and save. You have to start saving early and understand that even small amounts, invested over long periods, will add up to a sizeable amount come retirement,” says Annamaria Testani, Vice President of National Sales at National Bank Investments. She recommends saving rather than hoping for spectacular returns on the stock market.

Giving in to your emotions

Emotion is behind many irrational investor decisions. In fact, most investors have trouble dealing with the psychological aspects of managing their investments.

Behavioural finance and investor psychology have shown that people’s feelings about losing money are much stronger than their feelings about making money. For example, people usually prefer to earn $50 on an investment rather than make $100 and then lose $50, even though the end result is the same. In concrete terms, investors often keep stocks they’ve lost money on much too long instead of limiting the damage by selling them off as quickly as possible. Why do they make such an illogical choice? Simply to avoid feeling frustrated at the idea of losing.

These irrational decisions have been well known since the late 1970s thanks to the work of two psychologists, Daniel Kahneman and Amos Tversky, who developed prospect theory. They found that people have trouble accepting stock market losses and are willing to take bigger, irrational risks to avoid them.

Tip: Annamaria Testani explains that emotions are often caused by poor analysis of the facts. “For example, the Canadian stock market has been relatively stable over the past ten years, but market corrections do happen. That’s when investors often display irrational behaviour.” So, to avoid being too emotional, change your approach. Learn to recognize situations (market corrections, falling stock values, unnecessary risk taking to avoid feelings associated with a loss, etc.) where you tend to act irrationally.

Investing without a strategy

Many people invest in a disorganized fashion, without first developing a strategy. They choose stocks based on fleeting investment trends (THE investment product of the year!), advice from people without the required expertise (relatives or friends), or their own intuition. Investing under these conditions is extremely risky and makes for uncertain returns.

Tip: To increase your chances of success and choose your investments strategically, you should develop a game plan with the help of an investment advisor or financial planner. Annamaria Testani explains that reviewing your situation will help you make the right decisions. Your game plan must take into account factors such as your investment horizon, your reasons for investing, your goals, how much capital you expect to accumulate, and your risk tolerance profile. And, of course, a good game plan should be regularly updated to make sure it’s still valid and tailored to your needs.

Thinking that you’re going to beat the market

You can’t win every time. Sooner or later, you’ll take losses even if your information seems reliable. Investors tend to have trouble accepting this simple truth, particularly those with a bit of experience. Many are under the illusion that they’re almost infallible!

Tip: Don’t think you’re better than everyone else and don’t put your faith in statistics that are too optimistic. Be realistic, disciplined, and above all, humble. Experts in the field are there to help you maximize your investments and develop the right strategy. Even the best investors have had mentors; for example, Warren Buffett was guided by Benjamin Graham.

Diversifying too much, or too little

When it comes to investing, too much is as bad as not enough. Some people tend to scatter their investments, thinking that by doing so they are minimizing their risk. But this eliminates the leverage effect that a more global strategy provides. Investing your assets in too many funds or with a number of different financial institutions can be counterproductive and prevent you from having an overall view of your portfolio.

By not diversifying enough though, you can end up investing too much in the same industry or products, making your portfolio vulnerable if prices fall.

Tip: Don’t put all your eggs in one basket, but don’t put them in too many baskets either! With your advisor’s help, settle on a course of action aimed at balancing risk and ensuring long-term gain.

Follow these tips and you’re sure to be a more successful investor!

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