The Biggest Mistake You Can Make As An Investor
This is one of the biggest mistakes investors make.
And in the times like we’re experiencing now, many investors commit this investment sin more than ever.
It makes them do things they normally wouldn’t do…
They go against common sense and their investing rules…
They chop & change positions, and rack up unnecessary fees…
And ultimately they disrupt the very thing they’re trying to achieve!
That’s why I want to show you how to avoid this mistake (especially when times are tough), I want to remind you of your investing mantra, and ultimately show you the key to consistent, long-term profits.
But to get there, you first need to understand…
The Darkest Days in Stock Market History
The month of October is infamous in the stock market world.
On the 19th of October 1987 the Dow Jones (America’s main stock index) fell a whopping 22.61% in a single day.
It remains the biggest one day decline in American stock market history.
Scary stuff right?
Now, my point here is not to scare you but rather to help you face the realities of the investing world.
In 2008 the world saw the worst financial crisis since the great depression of 1929. Stocks were hammered down over 30% that year!
The fact is that these huge blowouts are real, and they hurt!
Imagine you started investing in the beginning of 2008 only to be down 30% by the time the year was over?
That’s enough to make most people quit.
To put it plainly, the investment world can be harsh.
But like anything in the investment world, and even more so when times are tough, you have to remember one simple thing…
Your Investment Mantra, And Why It Should NEVER Change
Don’t forget why you’re here in the first place!
The stock market is simply the best place to put your money to work over the long term.
Remember I’m using extreme examples here, but keep in mind that these are the outliers and they don’t happen every day, every year or even every decade.
Despite the risks of stock market crashes, equities (stocks) are still the best investible growth asset to put your money to work...
The chart above shows the annual returns on the Dow Jones each year since 1985 (it’s important to note this doesn’t include dividends).
Only 6 years have seen investors worse off at the end than at the beginning, with 2008 being the one that really sticks out.
Sure, leaving your money in the bank will guarantee you a rate of return, but for most of us the 5% a year that banks will give us won’t even match inflation.
So you’d basically be losing value on your stashed cash.
You need to ask yourself, what’s riskier?
Either you can accept that you’ll earn a small non-inflation beating rate of return.
Or you can have some money invested in places that, despite big setbacks like I’ve mentioned, have produced constantly strong returns year in and year out?
Of course, this also depends on where you are in your life stage.
The closer you move to retirement the less you want to have invested in stocks, and you do this to minimize the potential a stock market crash can have on your retirement.
Don’t forget however that even once you retire, you still need your money to generate some growth as well as producing your income.
The bottom line is that you can lose money in stocks, but if you have a long-term investment horizon and sensible approach, this is a risk most of us need to take.
Provided you have a long enough time horizon you can ride out any major shocks to the system.
The Game Every Investor Needs To Play
Let’s say Sam and Pat invested R1,000 on the 1st of January 2008.
Sam invested his money in the top40 stocks in South Africa and Pat kept his money in the bank earning interest of 6.5% (in theory this is higher than banks would have offered on this amount, but let’s give Pat a chance. We’ll also assume he incurs no fees).
At the end of September 2016 Pat’s cash in the bank will have grown to R1,763.35.
It’s not the worst return, but remember inflation reduces the buying power of your money as time passed.
Now given the turmoil the world experienced in 2008, Sam’s money would’ve had a much wilder ride.
At the end of the first year Sam’s R1,000 had lost 26% of its value (as stocks were hammered in 2008).
But after this huge shock to the system the global economy recovered and stocks followed suit.
So, at the end of September 2016 Sam’s R1,000 would have grown by 99% (including dividends) to an amount of R1,998.86.
If we had done a scenario where both Sam and Pat were investing constantly each month, the difference between cash and stocks would be even bigger!
So even despite a huge one year loss this is just to show you that if you have a long enough investment horizon, stocks have continuously proven to be the best long term generator of investment returns.
Keep reminding yourself, especially when times are hard, that you’re playing the long game.
History has proven over and over that stocks are the top choice for growth over the long term.
And I haven’t even touched on the real wealth killer yet…
It’s the irrational actions some investors take when times are tough that can have the worst effect!
The Biggest Missed Opportunity In The Last Decade
The chart above is the Satrix 40 ETF from 2008…
It’s basically a proxy for the performance of the top 40 stocks in SA (and the return Sam enjoyed in the earlier example).
Now in hindsight it’s easy, but can you think when would have been the worst possible time to sell stocks?
Cleary it’s at the end of 2008!
But at the end of 2008 stocks had just finished their worst year in decades…
People were in a panic and what was once thought of as ‘the immortal world of American banking’ suddenly seemed to be crumbling like a house of cards.
But human nature is a cruel beast.
Having felt the pain of losses like that, I know many people who sold out and moved into cash during these times.
After the pain of such losses many then continued to hide in cash earning a small amount of interest while stocks recovered, and even surpassed their levels before the crisis.
Accepting the loss is one thing, but irrationally disregarding your long-term investment ends up being even more painful.
Eight years later and the world is still turning...
Those who sold out at the bottom and are still in cash have missed out on huge opportunities!
Why Patience Is The Key To Profits
Patience is more important than intelligence when it comes to long term investing.
You can analyse the different ratios of one stock versus another to your hearts content, but it’s also important to step back and understand the classes of assets that you’re invested in.
If you are on the long road of investing, for 5, 10, 15 or even more years, you need to have some of your money invested in assets (such as equities) that have the ability to grow ahead of inflation.
You also need to understand the importance of staying on the path when times get tough…
This should be your investment mantra!
Acting irrationally in volatile times is one of the most dangerous things an investor can do, and will almost always leave you battered, bruised and behind when markets come right.
It will not always be smooth sailing, but when did a smooth ocean ever make a good sailor?
Until then, here’s to smart investing.
Analyst, The SMART Investor
The Money Lab