In my 21+ years as a life insurance and financial services advisor, dealing with high-level executives and top-performing entrepreneurs, I’ve met clients with different levels of experience with investing. It’s interesting to hear the questions that come up in my meetings, these questions have mostly been around restructuring existing portfolios.
If you’ve been having doubts like:
- Why don’t all of my asset classes perform optimally?
- What kind of asset classes should I be investing in?
- When should I restructure my portfolio?
- What percent of my savings should I invest into each class?
- Should I consider cryptocurrency?
Read on. Whether you’re a seasoned investor, a rookie, or have your investments parked through a financial advisor, it’s worth considering these six common pitfalls.
Pitfall #1: Appetite for Risk
Let’s talk about different asset classes within the same portfolio. When we have conversations with clients, one of the things that commonly comes up is people talk about their individual contracts. I had a conversation with one of my clients where two of his individual contracts gave him returns of over 13% per annum. But he was only focusing on the one contract that had performed at 3%-3.5%.
Every asset class is not going to perform well simultaneously, so it’s important to determine your appetite for risk. Remember, the pendulum swings both ways. This means that if an investment could give you a potentially higher rate of return, that also probably means that there is a higher level of risk associated with that which means you could potentially lose a lot more as well. And usually, the losses are greater than the potential gains.
Here is an appetite for risk questionnaire that will help identify your tolerance for risk, based on which you can identify the asset classes that you should be investing in. Once you define that it will be easier to determine the specific assets you would like to invest in.
Pitfall #2: Distribution of Assets
We’ve met clients in the past, who’ve had some portfolios perform tremendously well for them, giving them 25%-40% returns. While the others had given them anywhere between a 1% to even negative 10% loss in markets as well. And when we question them on these portfolios, what they tend to do is compare the little money sitting in the high return portfolios to the lots of money sitting in portfolios that give them a negative value.
For instance, if you had $1,000,000 worth of investments, out of which 10% of the portfolio ($100,000) is giving you 25% – 30% returns but about $900,000 or 90% of your portfolio has given you a negative return, then for sure, on the whole, your portfolio is down.
So, before you zero in on the performance of an individual asset class, it is very critical for you to know what appetite for risk you have and then determine what type of asset classes should you be purchasing, and what the distribution of money will be in each of those asset classes.
Pitfall #3: Understanding the Asset you Invest In
Don’t invest in any complex structures that you do not understand.
A seasoned investor may understand derivatives and leverage structured notes and if I don’t, I won’t be investing in them. A simple rule of thumb that I follow is if I don’t understand it, I don’t invest in it. A solution that is right for somebody else, may not be the right solution for me.
Pitfall #4: Rebalancing
Once you’ve identified the investment and asset classes that you think you understand completely, then invest in them, and put in place a review and rebalancing process for these investments.
For instance, if you’re investing in a portfolio that is balanced, you’re ideally speaking about 50% money in equities and 50% money in fixed income or bond products. About six months from now, your equities may have done really well and the portfolio may have shifted from 50-50 to maybe 60-40. At that point in time, it’s important for you to look at your portfolio and rebalance it back to the original 50-50.
If your appetite for risk is balanced, or aggressive for that matter, then you need to ensure that the assets that you currently hold are sitting in that space as often as possible.
This would also mean any profits that you may gain in the course of the term may make your portfolio unbalanced. While ensuring you get higher returns on a regular basis is definitely something to go for, ensuring that you’re doing that within the limitations of the risk that you would like to take on is very, very critical. Else a loss in this specific situation could mean you lose more than you were ready to lose.
Pitfall #5: Not Having Rules
It’s best to have rules. You don’t go into a casino with your entire bank account, and the same should be true for investing. You need to have a mindset of when is enough before you start the investment plan.
If you’re chasing a growth rate of 10% per annum for instance, then you need to be prepared to pull the trigger on that 10% when you get there- without having to think about the possibilities of a better return.
If you must change those rules along the way, that is fine. But not following your own rules for investing is where things can go considerably wrong. You also want to make note of your liquidity levels at the time of setting these rules. Maybe you were sitting on more liquid cash at the time so you were in a position to take on a fair bit of risk. Does that same level of liquidity still apply to you? If not, then it might be time to reconsider the investing rules you set for yourself.
Pitfall #6: To Invest in Crypto or Not?
My opinion on this goes back to what you would do at a casino. We don’t go to the casino and put all our money on the line with the assumption that we might be able to win a couple of million dollars on winning a specific gamble.
The same rules apply for investing in cryptocurrencies, understanding it is very critical. It is a fairly new asset class and people have definitely made millions as a result of this, so ignoring it may not be the best solution. But being clear about how much you want to get in with and at what point in time is a gamble. As long as you’re ready to gamble, the next question is how much of your life savings would you want to gamble with?
Pitfall #7: Opportunity Cost
People often shy away from exiting portfolios because of potential exit penalties they may get hit with. But remember, you’ve got to always consider the opportunity cost.
Opportunity cost, is figuring out whether your money sitting where it is right now is giving you the right kind of exposure to potential returns, or could it be performing better elsewhere? It’s the cost of investing money in other markets that can give you a potentially higher rate of return.
The right way to go about it is to consider, ‘will this money work better for me elsewhere?’ For instance, let’s assume you have invested money in the S&P 500 Index. The index was at 3000 points at the time of investing is now at 4400 points.
If you wanted to invest more money into the index, you might have to free up cash by say, selling off your other assets. If you consider selling your property you might notice that you will lose 2-3% given when you purchased it and the fact that the property prices have dropped. You may then think that selling it now wouldn’t be profitable. Sure, you could be selling at a potential loss of capital from the first time you invested in that property. But the question you have to ask yourself is if you sold that property at a 2% loss and you invested it in, say, the S&P 500 Index where you could have netted a 30% growth, then would you still hold on to that 2% potential loss in the portfolio? And would you be willing to give up the potential gains of 30% at the same time?
We run into this situation with existing clients all the time, where we tell them to exit specific portfolios because we think they’ve done well enough in those portfolios and that they should consider investing elsewhere. The reason sometimes people don’t pull the trigger on investing elsewhere is because they consider the exit penalties associated with the current portfolio. But it’s important to consider that you may have been in a bad asset class which now has depreciated and moving money from one place to the other could ensure that you not only make up for that lost money at a quicker pace, but also that you earn higher returns than where your money is currently sitting.
And those are the 7 pitfalls of investing straight from a financial advisor. The pitfalls don’t stop here by any means, but ensuring you avoid these will give you significant peace of mind and financial returns.
Like a casino, investing can be a gamble or rather a game. I hope this helped demystify it for you. Feel free to leave me a comment below, or drop me a LinkedIn message if I can help answer any questions about your investments or audit your existing portfolios.