Newsletter August 10, 2021
Fear of Making Mistake
In real estate investing there is an alphabet of fears.
When it comes to home purchases there is FOMO, the Fear of Missing Out as home prices rise ever further out of reach. This fear causes people to get carried away in bidding wars and to potentially overpay for houses. FOMO and the resulting buying panic has been a self-fulfilling prophesy for some years now. When it comes to selling a home there is FOSC – Fear of Selling Cheap. This can lead to lack of supply and inflated asking prices.
In investing the biggest fear has traditionally been the fear of loss. The academics call it loss aversion
But let me suggest a slightly different fear that investors have. FOMM – Fear of Making (a) Mistake.
It’s bad enough to incur an investment loss. But I think what often hurts more is acknowledging any sort of self-inflicted investment loss.
A decline in your portfolio that is caused by a general decline in the markets causes some stress. But a decline that is caused by what feels like a mistake that we made ourselves is harder to take and causes more stress. It’s human nature to be more comfortable when setbacks can be blamed on others or general circumstances as opposed to our own actions.
So, I think investors are often held back by a conscious or even an unconscious FOMM – Fear of Making Mistake.
Investors with ample cash wonder if putting money to work in the market will turn out to be a mistake especially when markets are at or near record highs. On the other hand they also have FOMO – the Fear of Missing Out on further gains.
Investors considering individual stocks have an even larger FOMM since picking an individual stock that goes down involves more choice and if it turns out to be a mistake it’s harder to blame it on external circumstances and is more likely to cause stress and regret. Also, an individual stock is subject to more down-side risk than the market average index.
And investors holding individual stocks that have done well wonder if selling some or all will turn out to be a mistake (it usually is with the better companies) or will holding such stocks at their highs turn out to be the mistake?
In summary, investors are constantly faced with FOMM.
So… how should investors deal with this FOMM?
One common way that people deal with this is to simply never invest even when funds are available. Over the years that will definitely lead to missing out on substantial gains. But such a mistake of omission is often less psychologically painful than a mistake of commission that goes bad. And non-investors can simply refuse to pay any attention to markets. If they never think about their “missing” returns, they need not be bothered by them. Of course for actual investors this strategy is a non-starter.
Another strategy is to turn all investment decisions over to an advisor. In some cases this will consist of giving a portfolio manager complete discretion to manage funds. Or it can consist of fairly blindly following an advisor’s suggestions. There is a true psychological benefit here in that there is someone to blame for mistakes. Stress and regret over our own decisions are real mental health concerns and the chance to avoid such stress has real value.
A strategy that I think has merit for do-it-yourself investors is to put a portion of investments funds into well diversified Exchange Traded Funds such as the likes of VBAL or VCNS or VGRO. See the article where I discuss those. By putting a portion of funds into the broader market including fixed income, investors can reduce the portion of the portfolio that is riding on their own individual security selection decisions. While this may reduce returns, especially over the longer term, it will also increase returns in some periods and should lead to lower stress levels at times. With a lower potential FOMM, it may be easier to pull the trigger on such an investment compared to investing in individual stocks.
In conclusion, FOMM may explain part of what you are feeling as you consider investment decisions. By understanding that FOMM is a normal human feeling you may be better able to deal with it.
The following two items are updated versions of short articles I recently wrote for an Investment Newsletter that I contribute to (IWB, The Internet Wealth Builder).
HELPING YOUNG PEOPLE GET STARTED INVESTING
Today, I’d like to share some thoughts on how experienced investors can encourage the young people in our lives to get started investing.
Young people face many barriers to start an investing program. These include lack of funds, skepticism about past or future returns, fear of loss, lack of knowledge of how to get started and lack of knowledge as to what to invest in. But perhaps simple inertia is the biggest barrier of all.
There are reams of data about past returns but some figures that might be relevant to young people are that the Toronto Stock Exchange Composite Index was at 8,414 at the start of the year 2000. As I write, it is at 20,504 for a gain of 144% or 4.2% per year compounded.
More impressively, the S&P 500 index has risen from 1,469 to 4,438 over the same time period for a gain of 202% or 5.3% compounded annually.
Dividends would have added to those gains. And keep in mind stocks at the start of the year 2000 were at high levels. The results above came in spite of several very major stock market declines (the “tech wreck” and the financial crisis as well as the COVID crash of March 2020).
The better performance of the U.S. market illustrates the wisdom of diversifying investments across countries.
The barriers related to fear or lack of interest are difficult to overcome. But at least the barriers related to how to get started and where to invest can be very easily dealt with. And a push by a veteran investor could overcome the inertia factor.
My advice to young working people who want to (or who can be convinced to) get started investing is as follows:
- Open a self-directed Tax-Free Savings Account (TFSA) and/or a self-directed Registered Retirement Savings Plan (RRSP).
- Set up a monthly automated contribution.
- Initially invest the funds mostly or entirely in a broadly diversified low-fee exchange-traded fund such Vanguard’s VBAL or iShares’ XBAL.
These particular exchange-traded funds provide the ultimate in simplicity. They are well diversified across different companies in different sectors and are also well diversified geographically. They also include a significant allocation to safer fixed income investments. Truly, these funds can be a one-stop solution especially for those just getting started investing.
In theory, a heavier weight to equities might be appropriate. But that runs a higher risk of a material market value loss, which could cause a young investor to get turned off from investing.
It can also be very appropriate to invest a portion of the funds in several individual companies that a young person is familiar with. Seeing funds invested in the likes of Apple or Amazon could really whet the appetite for investing. But perhaps investing in individual stocks should be left for later as the first goal is to get started and so simplification might be the priority.
The biggest key of all to building up an investment portfolio over a lifetime is to get started. An adequate return (net of fees) is also very important. But compound returns over time simply can’t work its magic until there are some funds in place for it to apply to.
Young people with incomes over $50,000 should probably focus on building up an RRSP for retirement savings. The TFSA might be preferred in theory, but I would caution that TFSA funds are very accessible and therefore far more likely to be spent long before retirement.
While lower fees and higher returns are always desirable, my advice would be to not sweat either the fees or the returns in the early years. When a young person is building up a portfolio through monthly or annual contributions, the initial growth will come largely through the contributions and not the returns and will be little affected by fees.
There will come a time when most of the growth will come from returns and when minimizing fees becomes more important. But initially the focus should be on making contributions to build up the portfolio. For this reason, there is nothing wrong with getting started with mutual funds if setting up a self-directed account is too daunting or just not of interest. In this case look for a relatively low fee balanced mutual fund. Almost any financial institution will offer those along with a monthly contribution plan.
The difficulty that most young people will face in coming up with any extra funds to invest has to be acknowledged. In some cases, perhaps investing must be put off to the future. But getting started with even $100 per month is preferable to not starting.
For most people, the path of least resistance is to invest where they bank. This is particularly true for those that deal with the large Canadian banks since they all offer self-directed investment accounts with low trading fees and usually no annual fee if a monthly contribution is set up.
In conclusion, it is easy for young people to get started investing and to achieve a low-fee lower-risk balanced portfolio. But they may need a bit of a push to actually do so. If older investors can encourage one or more young people in their lives to get started, the reward of seeing them get on a good path to financial success is likely to be an extremely good return on such efforts.
INVESTOR MISTAKES COME WITH THE TERRITORY
Anyone who has been a self-directed investor for any length of time has surely made a few mistakes and/or has some regrets. There are the mistakes of commission, where we have taken a regrettable action, and there are the countless mistakes of omission where there are actions that, in hindsight, we wish we would have taken.
At times, these may weigh on our minds. But the fact is that investment mistakes or regrets are inevitable and there is no point beating up ourselves about it.
Those who leave all their investment decisions to a portfolio manager or advisor have the luxury of someone to blame when things go wrong. But do-it-yourself investors, including those who make use of services like this web site, have to be prepared to live with and forgive themselves for their own mistakes.
Some of the most common mistakes or regrets that we all tend to make include the following:
Selling winners: A popular old adage is that “you can never go broke taking a profit”. But Warren Buffett has argued that selling your best stocks can “turn a mountain into a molehill”. He has also argued that selling or reducing your biggest winner simply because it has become too large a part of your portfolio is akin to a sports team trading their star player because they are too dependent on him or her. Most long-time investors are only too well aware of the regret that can arise from selling winners. It’s not a guarantee but, on average, in investing as in life, winners have a tendency to keep on winning.
Anchoring: A very common cause of investment mistakes is that we tend to fixate on past stock prices such as a high or the price we paid or a price at which we thought about buying but did not. This can lead to such things as a refusal to sell losers or a refusal to buy a stock simply because we failed to buy earlier at a lower price. The cure for anchoring is take a fresh and logical look at the evidence as of now.
While we all make mistakes, as investors we should congratulate ourselves for having avoided the biggest mistake of all: Failing to invest over a lifetime.
The Toronto Stock Exchange index was in the news recently as it surpassed the 20,000 level for the first time. Ten years ago, on June 1, 2011, it was at 13,528. Twenty years ago, it was at 8,251. Thirty years ago, it was at 3,537. The evidence is very clear that over a lifetime, investing in equities is rewarding.
This is not about to change. The output of the economy is ever more dependent on capital assets of all kinds and ever less dependent on labour inputs. To get our fair share of the output of the economy, it will be increasingly necessary to own capital and the way to do that for most people is to invest in the markets.
Rather than dwell on past mistakes and regrets, investors can only look to the future, safe in the knowledge that as equity investors they are on the right road even if there will be some inevitable potholes.
Investors should also encourage those in their life, especially younger people, not to make the mistake of failing to become investors over their life if they possibly can. It’s very easy to get started investing. The simplest and safest approach for those just starting out is to have their bank set them up with a monthly investment in a balanced mutual fund. Becoming a self-directed investor or other more sophisticated approaches can come later. The key for non-investors is to avoid the huge mistake of never getting started.
InvestorsFriend Inc. August 10, 2021