Content provided by Grant Engelbart, CLS Portfolio Manager
Let’s step out of the world of “best practices” and “prudent management” for a second and explore some of the things you should avoid when investing. I may or may not have experienced or committed the following acts in my personal investing, but either way it should serve as a guide of what not to do!
Probably one of the easiest to do, and most frequently violated of these rules I am laying out. Who doesn’t love to buy a 5-star fund? The headlines and the success stories, it’s so easy to jump on the band wagon. Look at Apple in 2012 – everyone and their mom thought that thing was going to $1,000 a share. Even some high yield bond funds owned it! Nothing like a nice 40% correction off the highs to teach you not to do that again!
We’ve also seen that more often than not, the future performance of underperforming managers tends to reverse, and the future performance of top performing managers tends to falter. Part of the reason investor returns are so much lower than market returns.
Buying something you don’t understand
This has big implications in ETF land. The structure of ETFs and their underlying constituents are something we at CLS strive to make sure we grasp before investing, because if not, it can really bite ya. I’ll use an example I have used in the past – trying to “buy” the VIX. The VIX is not investable, and one of the ETP products that provide access to VIX futures contracts seems like a no brainer to some. Well, even if the VIX never moves, when you hold this product you tend to lose 5% or more a month just in futures roll costs. That’s an expected return of over -45% even if the market never moves!
We’ve all heard it many times, but yet many continue to poorly diversify their investments. Traditional academia points towards 20-30 stocks will diversify away single-company risk, however the discussion has moved to much broader terms, including being properly balanced across many types of asset classes. Take this year as an example – if you owned the 30 stocks in the Dow Jones Industrial average, you would have made just under 2%. However, if you had a 60/40 split between the Russell 3000 and Barclay’s aggregate bond index, your returns would be almost 3x higher and with nearly 30% less risk.
The good news is many of us at CLS, and likely many of our advisors, have already made these mistakes – and learned from them. It is up to us to educate our clients and keep them focused on their long-term goals.