At Cypress we believe that one of the most important (if not the most important) aspects of our job as portfolio managers is to educate prospective and existing clients on investing. We strive to give our clients a firm understanding of the fundamentals of how capital markets work and to ensure they appreciate the difference between ‘investing’ and ‘trading’. We want our clients to realise that the financial services industry is often motivated to sell products that are not necessarily in the client’s best interest. Our experience has shown us that financially well-informed clients have a much better understanding and appreciation of the markets and the securities they own and are ultimately in a stronger position to make the right long-term investment decisions.
Time and again we see investors make mistakes that are often ruinous to their financial health. Below we have listed our “Top-10 Biggest Mistakes Made by Investors”
1. Confusing volatility with risk.
Volatility is the hourly, daily, monthly and yearly gyrations in the market. Risk is the permanent loss of purchasing power. The two are very different and should not be confused. Volatility is primarily a risk in the short-term, but actually creates opportunities for investors with long-term time horizons.
2. Seeking income rather than total return.
Too much focus on income can lead to investors chasing yield and neglecting to evaluate the underlying fundamentals of a given security. The debacle in sub-prime mortgages in 2006-2008 is an extreme example of this phenomenon. A properly constructed portfolio will have balance of income, value, and growth.
3. Letting emotions override rational decisions.
We cannot overstate the importance of this issue. The stock market is inherently a volatile place and investors must learn not to let emotions overcome rational investing decisions. Numerous studies, including Dalbar’s influential ‘Quantitative Analysis of Investor Behaviour’, have shown that the biggest mistakes investors make are rooted in emotions.
4. Emphasising short-term performance.
Material investment returns are accumulated and compounded over time, making short-term performance all but irrelevant. Portfolios should be re-evaluated on a systematic basis or when investor circumstances change; they should not be re-evaluated based on the latest fluctuations in the market or in reaction to a news headline.
5. Neglecting to diversify portfolios properly.
Proper diversification is critical to ensuring that investors earn an appropriate return over the medium and long-term.
6. Paying too much attention to short-term market fluctuations.
The day-to-day movements in the markets are simply noise and distract investors from the important decisions such as asset allocation, diversification and protecting the purchasing power of their assets.
7. Believing that active trading adds value.
Research has shown that the cost and taxes associated with active trading have a material negative impact on returns – so not only does active trading not add value it subtracts value.
8. Believing that government fixed-income securities are ‘risk-free’.
Inflation and rising interest rates can have a material impact on government fixed-income returns, so while the interest payments and return of principal may be ‘guaranteed’ the preservation of the investor’s purchasing power is not. We see our job as portfolio managers as primarily one of maintaining and growing the purchasing power of invested capital.
9. Believing that big companies are ‘safe’ and small companies are ‘risky’.
Recent history has seen some of the largest companies in the world either go bankrupt or reduced significantly in size. Business fundamentals such as competitive positioning, industry dynamics and balance sheet strength are important regardless of the size of the company.
10. Confusing the short-term day-to-day ‘entertainment’ of the markets with long-term ‘investing’.
Proper investing is a rational and methodical exercise. The daily gyrations of the market are simply ‘noise’ that may be interesting or entertaining, but adds little to the process of constructing an appropriate investment portfolio.
An educated investor should know what questions to ask their investment advisor either during initial discussions or during their regular portfolio review sessions. Below we have set out some questions that we believe investors should ask their investment advisors and that advisors should be in a position to answer.
1. How does the asset mix in the portfolio match with the Investment Policy Statement?
Should there be any changes in the Investment Policy Statement? A portfolio should be set up according to an investor’s individual circumstances. Investment Policy Statements should take into account cash needs, risk tolerance and any other relevant factors.
2. How much risk was taken to earn the return?
When performance numbers are evaluated it is important to consider the risk associated with those returns. Higher returns are of course desirable, but not if they mean too much risk.
3. What is it costing me to have the portfolio managed?
This is crucial. Fees in investment management are often opaque and wrapped up in management expense ratios, load-fees, and commissions. Any good investment advisor should be transparent and forthcoming with what fees are being charged to the account.
4. How much trading has taken place?
A competent advisor should be able to explain why any trading has taken place within the portfolio. Excessive trading or ‘churning’ portfolios is a recipe for high commission, high taxes and low returns.
5. How do you expect to add value in markets which are very ‘efficient’?
The ‘efficiency’ of the market in assigning value to securities is a matter of debate, especially at the macro level. What is beyond debate is that outperforming the ‘market’ is extremely difficult, especially in the medium to long-term. Adding value requires experience and a disciplined approach. We would advise investors to be skeptical of any advisor or manager who believes it is easy to consistently beat the market.
We are always on the lookout for interesting articles, charts and other resources that help give perspective on the markets and investment principles. This section includes some concise information that we believe is relevant reading for those hoping to become better investors. We endeavour to keep this material updated and relevant, so check back often.
Over the years we have read hundreds of books on the market, investing and the economy in general. See the attached for some of our favourites.
Along with their detailed account holdings, Cypress clients receive our quarterly report that outlines our views on the current state of the market. See below for our most recent quarterly report.