The 8 biggest mistakes investors make Dario Michalek Vision Capital Management
We are confident that the information that follows can provide compelling reasons to look hard at your investments and propel you to make better more informed investment decisions that will help you reach your financial goals and provide greater security for the future in this challenging market environment. We are probably going to have one of the worst recessions we've had since the Second World War. It's not a good scene. Jim Rogers V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 2
The 8 Biggest Mistakes Investors make 1. Buy and hold mentality 2. Investing in mutual funds 3. Trying to time the market 4. Misconception of what true diversification is 5. No risk management plan 6. Chasing performance 7. Investing without a plan 8. You are your own worst enemy V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 3
1. Buy and hold mentality Why are investors so dependent on a bullish market? Investors much like mutual funds are what we refer to as bench huggers. Bench Huggers stay close to the S&P 500 and mimic its ups and downs, but because of fees and large turn over most don t beat the index. Furthermore investors with a buy and hold mentality have little protection against bear markets. When the markets are in a trouble and move lower investors portfolios move lower as well. Most investors painfully experienced this during the bear market at the turn of the century. Investors make money when the markets are bullish, they totally depend on it. During the bear market in 2000-2003 the markets moved lower by as much as 50-75%. This resulted in losses of trillions of dollars for investors and most just watched from the sidelines as their retirement money evaporated into thin air. V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 4
2. Investing in mutual funds Why do mutual funds historically have poor performance? The vast majority of mutual funds have historically underperformed the stock market. The power of compounding (which makes long term investing so lucrative) only magnifies the reasons why mutual funds should be avoided. For example, starting with a portfolio of $10,000 and using the performance numbers in Fig. 1 over a 30 year period at a growth rate of 10.3% a year the investor would end up with $1,893,500.28 which seems like a good return until we see what would happens if the average mutual fund had at the very least kept up with the market at 13% the initial investment of 10,000 would have increased to $3,911,589.80 or basically doubled. Measure 1980-2003 SP-500 13.0% Mutual Funds 10.3% Return Shortfall 2.7% Return Shortfall % 21.0% Fig. 1 Source: Lipper V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 5
In spite of the lack of performance in mutual funds investors are blindly parking their money in this investment category. Mutual fund assets have grown dramatically as Fig. 2 clearly shows. From 1998 to present the markets have gone nowhere and on average mutual funds have underperformed by 2% and yet worldwide mutual fund assets have more than tripled in just ten years. How could this be? How could so many investors put so much money in such a poor investment? WORLDWIDE TOTAL NET ASSETS OF MUTUAL FUNDS (Trillions of U.S. dollars, end of year) 30 25 21.8 26.2 20 15 11.4 11.9 11.7 11.3 14 16.2 17.8 10 8.7 5 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Fig. 2 Source: ICI Investment Company Institute V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 6
High Fees THE 8 BIGGEST MISTAKES INVESTORS MAKE ] How does a mutual fund have higher fees? Mutual funds charge very high fees compared to other investments for what you get. They charge purchase fees, redemption fees, exchange fees, account fees, management fees, fees for going to restroom, etc. Just buying a mutual fund puts you in the red from the onset. The SEC does not limit the size of sales load a fund may charge, but the FNRA does not permit mutual fund sales loads to exceed 8.5%. That is a rediculously high commission. This means your mutual fund needs to increase in value by about 10.0% just so you can break even! What about the backend loaded funds? They can be even worse! Sure, all your money goes into the fund but now you re locked in for up to 10 years if you wish to avoid paying a load fee. If you need the cash before then, you have to pay a commission on not only the amount you invested but also on the gain as well! What about no load funds? There is no such thing. All funds have a load on it. The financial planner will get his commission for selling you the fund. If you do not pay the commission, then the fund pays it. Guess where the fund eventually takes the money from? Minimizing investment costs is critical to long-term investing success. Research has repeatedly shown a powerful relationship between low costs and relatively high returns. This relationship is easy to exploit, since cost is the component of net investment return over which investors have the most control. V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 7
Capital Gains Tax Is it possible to lose money and still pay capital gains tax? During a crash or market correction, the mutual fund value will drop. This drop can panic many investors, who will then pull their cash out (fees and backend loads be damned). If the fund is fully invested, the fund manager will have to sell some of the holdings in order to pay off the people redeeming fund units. While a normal investor would sell their losers and keep the winners in a down market, the reverse happens in a mutual fund. The fund manager will sell off the winners to pay off the people cashing in their fund so he can look good at bonus time fund managers don t get big bonuses for selling holdings at a loss. While this is good for the fund manager, it triggers a capital gain to you. So you are paying capital gains tax on a fund that is declining in value! Talk about getting double screwed! V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 8
3. Trying to time the market How does market timing hurt investors? Another factor that affects returns deals with market timing. Most investors will rebalance the portfolio based on their perceived risk in the market place and since most our wrong or off in their predictions they are usually living money on the table. Studies demonstrate that the vast majority of investment returns can be attributed to the asset allocation decision. Active investment decisions such as market-timing and/or stock selection have a more modest impact and, on average, reduce portfolio return. Forecasts are financial candy. Forecasts give people who hate the feeling of uncertainty something emotionally soothing V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 9
4. Misconception of what true diversification is How are investors so poorly diversified? Investors and mutual funds are very limited in their ability to diversify and typically only invest in equities, bonds and cash. One of the best ways to improve returns and reduce risk is by diversifying among different assets classes, sectors, regions and by correlation. Investors mostly invest in stocks or equity mutual funds offering very little in the way of diversification as stocks generally have a very high correlation to one another and move closely together which also represents greater risk. Diversification is a powerful strategy for managing the risk of return volatility, allowing investors to establish portfolios with risk profiles that are consistent with their goals and preferences. A more efficient investment portfolio can be created by diversifying among investments with low to negative correlations V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 10
5. No risk management plan Risk has many dimensions, and investors should weigh shortfall risk the possibility that a portfolio will fail to meet longer-term financial goals against market risk, or the chance that returns will fluctuate. To achieve long-term financial goals, many investors must pursue the relatively high expected returns available from stocks and bonds. Risk is undesirable, but a fundamental law of the financial markets is that higher returns are associated with a higher level of market risk. Market risk, or variability risk, can be defined as the variability of returns. A second, equally important, concept is shortfall risk the possibility that a portfolio s value will be insufficient to finance the targeted goal. Paradoxically, a portfolio that takes a conservative approach to market risk may in fact be exposed to a high degree of shortfall risk. V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 11
When there is a 50 percent loss, a 100 percent gain is needed just to get back to even. This is an exponential curve that steepens considerably when losses are greater than 20 percent. In order to protect capital, a primary concern is to keep losses under 20 percent, otherwise too much profit is wasted in the effort to get back to even. Percent Loss % Gains Needed to Recover 20% 25% 35% 54% 50% 100% 65% 286% The second, and less obvious conclusion, is that staying close to the last high water mark (equity high) and consistently making small profits provides a greatly enhanced compounding effect. Risk comes from not knowing what you re doing Warren Buffet V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 12
6. Chasing Performance Performance chasing is a losing strategy! The tendency for investors to chase performance by buying an investment simply because its price is rising has proved to be a poor long-term strategy. Indeed, asset-allocation decisions based on such so-called momentum strategies have empirically underperformed portfolios that are constructed through careful strategic asset allocation. The appeal of performance chasing altering a portfolio s asset allocation in response to short-term market developments is strong. Successfully buying low and then selling high at precisely the right moments promises exceptional rewards. However, the opportunities that are clear in retrospect are rarely visible in prospect. Empirical evidence has repeatedly shown that the likelihood of success is remote. Because investment returns tend to revert toward a long-term mean over time, however, performance-chasing can be hazardous. The greatest inflow of funds into a given mutual fund or stock typically occurs immediately after it has generated above-average performance and immediately before it starts to underperform. Identifying those investments that have outperformed in the past is simple. Identifying those that will consistently outperform in the future is extremely difficult. V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 13
7. Investing without a plan From the outset, every investor should form an investment strategy that serves as a framework to guide future decisions. A well-planned strategy takes into account several important factors, including time horizon, tolerance for risk, amount of investable assets, and planned future contributions. At the outset, individuals should have a clear sense of what they want to accomplish and the amount of risk they re willing to bear, Creating an investing plan is arguably the most important step in investing. Your plan is the road map which will assist you in achieving your long term financial goals and aspirations. The old adage, if you fail to plan, you plan to fail, relates 100% to successful investing. If you haven t created a plan or don t know how, here are the basic steps you need to take: 1. Determine your time horizon 2. Gauge your level of risk tolerance 3. Add the proper investments that agree with your investment plan V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 14
8. You are your own worst enemy Many investors have confused the luck of riding the wave being at the right place at the right time with the skill of surfing the wave, They have had to learn the hard way the lessons of humility and sobriety when it comes to this market. In other words, to make money in today s market, many investors may need to change their evil ways. And they should start with the bad habit that s a direct result of the long-running bull market: overconfidence. Just as most people rate themselves above-average drivers, many investors overrate their skill at picking investments. A survey of American Assn. of Individual Investors members found a sample group overestimated their own performance and their ability to beat the market. The investors believed their returns were an average 3.4 percentage points higher than they actually were. When asked to estimate how well they did relative to market benchmarks, such as the S&P 500, the investors guessed they earned an average 5.11 percentage points better than they actually did. V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 15
Few individual investors have a clear notion of their true returns. Instead, many play up their winning investments in their minds, while glossing over their losers. The conviction that they can beat the market leads many investors to trade too much, which also hurts their performance. Investors either gamble with a small amount of money, risking it all on a single bet or a small number of stocks, or we let our environment (media, friends, working peers ) dictate our investing choices, biases and emotions. V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 16
The Vision Capital Advantage Performance- A proven track record that has significantly outperformed the S&P-500. Absolute return Strategy- Has the ability to profit from bullish and bearish market environments Global Diversification- Highly diversified portfolio investing across 100 global markets, 14 exchanges and six continents. Competitive Fee Structure- Unlike many brokers we make no profits on trades or sale of the investment product, the majority of fees are based on performance. Professional Management- We are highly committed to our clients with one goal in mind To Perform. Ten years of research- Extensive experience and research in market behavior implementing a systematic, disciplined and consistent approach. Dynamic Investment Process- Investment process was developed with the idea to take advantage of multiple market environments and scenarios, including market shock events. PLAN. PRESERVE. PROFIT. V i s i o n C a p i t a l w w w. f o r w a r d t h i n k i n g 1-8 6 6-8 2 9-9 5 1 9 Page 17