Discriminating investment behavior is hard to teach – even to exceptionally intelligent people of all ages and genders. Many people tend not to focus on the fundamentals. They get their information from the financial media. And especially if they’re members of the younger generation, they’re in too much of a hurry – an ironic state of affairs given the long timeline towards retirement that their relative youth gives them.

These are just a few of the errors and misjudgments investors are prone to make, and there are many more. What we want to do in this blog post is distil all of those errors into five major ones.

If you can avoid these pitfalls, you’ve got a serious shot at success. We’re not going to discuss several of the more obvious pitfalls such as not having an investment goal, failing to plan, or trying to time the market. Rather, we want to focus on a few of the serious underlying reasons why far too many investors make self-defeating elementary mistakes. Such investors tend to:

  1. Buy stocks, not businesses
  2. Misunderstand the concept of compounding gains
  3. Become victims of impatience
  4. Misconstrue the potentially corrosive effects of inflation
  5. Overlook the impact of investment fees

So how can you be a smarter investor?

Buy Businesses, Not Stocks

Seasoned investors look for businesses with a long-term future. Their operations are credible and their pricing strategy – their pricing power – makes sense given the competitive environment the company is operating in.

Their management is sound and their balance sheet believable. Boring though the company might appear, it seems able to deliver profits in almost any economic environment. That’s one to buy.

Understand the Concept of Compounding Gains

The most frequent mistakes happen when investors attempt to become traders and time the market. Timing the market may work for a short period, true. But slow and steady wins the race.

Long-term compounding gains delivered through share price appreciation and dividends will, almost always, outpace the nominal gains achieved through rapid day-trading and short-term holds.

Don’t Become a Victim of Impatience

Jumping in and out of positions results in high portfolio turnover. This in turn leads to transaction costs and unnecessary taxes, both of which could be avoided if you were patient. All these pitfalls, and others, eat away your returns and minimise your long-term gains.

Never forget that your competitors are, increasingly, supercomputers. It is rumoured that the folks at Renaissance Technologies, the world’s most successful hedge fund group, have access to more computing power than the U.S. state department.

This, it has been reported, amounts to more than 100 teraflops of power, which translates into the capacity to perform more than 100 trillion calculations a second.

Don’t try to beat what you don’t have a chance of beating. You won’t win.

Understand the Potentially Corrosive Effects of Inflation

We’re entering an inflationary environment. Canada’s annual inflation rate stands at an 18-year-high, driven by rising gas prices, soaring housing costs and elevated food prices. Inflation increased to 4.4%, to reach its fastest clip since February 2003, Statistics Canada data showed. It was the sixth consecutive month in which headline inflation topped the central bank’s 1-3% control range.

Putting your cash under the mattress might preserve your nominal money, but it won’t help you over the long run as prices continue to rise and make what money you currently have less valuable.

Anyone Who Hopes to Stay Ahead of the Game Needs to Invest, But…

Historically, shares have delivered the best long-term returns – but that doesn’t mean they’re immune to inflation eating away at them. For the investor, higher levels of inflation mean we need greater returns to beat it, which means accepting more risk.

The key is to look for businesses that can pass price increases on to customers. This means strong brands and high-quality businesses with enviable competitive positions. Companies delivering strong margins now could be good candidates, as they already demonstrate continued pricing power.

Companies with lots of fixed debts could see inflation help erode the burden – inflation eats away the value of debt, too. Inflation can also lift the prices of fixed assets. Businesses with these characteristics – what we’d usually call ‘value’ businesses – have been out of favour the last few years. Don’t ignore them. Value as a style of investing will likely benefit if inflation ticks up.

Never Overlook the Impact of Investment Fees

You’ve heard about the magic of compound interest? Well, we’ve got its darker side: compounding commissions.

Every percentage point of commission that you pay matters, and over time the differences are huge. In our experience, many investors don’t even know how much they are paying for their investment activity.

Remember this: Every single cent of commission reduces your returns.

If you hold a mutual fund that charges you 2% yearly commission to manage your capital, that fund has to generate an additional 2% of return above the market return just to cover its costs.

Talk to an Expert

An expert is an individual to whom people turn to for wise and insightful counsel. An expert is someone who knows a lot about a subject and can give good advice. The three credit union partners, Coastal Community Credit Union, Coastal Community Private Wealth Group, and Interior Savings who stand behind Everything Retirement are just that. Experts. Now, some final thoughts:

  1. The way to be a successful investor is no secret. That’s the secret.
  2. Investing in financial markets to create long-term wealth is simple but not easy.
  3. Your behaviour matters much more than the stock market for investment returns.
  4. Investing, like most competitive sports, is 90% mental.
  5. Thinking based on evidence is more important than intuition based on gut feel.

Investing teaches you a lot about yourself – trust us, you’ll see!