I regularly get approached by “do-it-yourself” investors, many of whom come from the Moneyweb community. Most want verification or confirmation that they are on the right path, but many want more specific advice on fund selection and strategic tax planning.

Many of the investors are well-informed and capable of managing their own investments decently. Very few, however, are capable of proficiently managing their overall holistic financial planning, which includes tax structuring and estate planning. In many cases, it is not a matter of not having the technical ability but rather one where two sets of eyes work better than one.

The common problem is that people cannot identify their mistakes and keep repeating or overlooking them. It is also very difficult to manage and overcome one’s biases, which often leads to less efficient portfolios and strategies and costly mistakes.

The biggest challenge that do-it-yourself investors have is to stay on top of legislation and to remain informed of changes to investment teams, taxes, new funds, and up-to-date data and strategies provided by the analysts of the respective investment houses. Many advisors face the same challenges, and here I refer to advisors who try to be all things to all clients. Unfortunately, jack-of-all-trades and “know-it-alls” cannot stay abreast of everything and still do a decent job for every client.

This, unfortunately, also holds true for do-it-yourself investors for exactly the same reason … Somewhere along the line, the ball is going to be dropped, primarily if you are still employed full-time with deadlines and targets that have to be met. Financial planning and investment management cannot be done on a part-time basis – it is a full-time commitment (if you want to do it 100% correctly).

Like any other profession, such as attorney, doctor, accountant, and so forth, professional financial planning is a specialist occupation that requires particular skill sets and constant learning. Don’t for one minute confuse professional financial planning with buying or selling a product. The “product” of the professional financial planner is the planning and the long-term ongoing monitoring and management of that plan, which may or may not include a product.

Merely looking at Morningstar returns of the unit trust sector and deciding on three funds to “buy” based on their fantastic returns and ranking over the last year is not financial planning. 

Today, I want to highlight 10 of the main areas where do-it-yourself investors (and some advisors) get it wrong. I will follow this up next week with 10 more errors that I come across regularly:

1. Too many funds are held in a single investment

I get the impression every time there is a marketing campaign for a new fund, many people invest in it. Using uncorrelated funds makes sense. It reduces volatility and should provide a decent outcome, but there should be a clear strategy behind the fund selection. Using, for instance, funds with different mandates in the same portfolio distorts the objective of each fund. Using a combination of a stable fund, a medium equity fund, a balanced fund and an equity fund from the same fund manager leads to a “bastardised” (sorry, I don’t have a more descriptive word) portfolio. Each sector-specific fund uses chosen equities and other assets to fulfil its objective and mandate. Unless you are covering various strategies in one investment, adopting a “bastardised” strategy does not make sense and although the underlying returns may be satisfactory per fund over different periods, it is very likely that the overall return will disappoint. Furthermore, deciding on a benchmark to measure returns against will be very difficult.

2. No clear investment strategy

People find it difficult to explain what they are investing for. If you do not know why you are investing (apart from you know you must accumulate wealth), how can you determine an investment strategy? Asset allocation is crucial and must vary according to the term of the investment, liquidity requirements (when and where you will require liquidity), income expectations, and wealth transfer (which will determine the structure of the investment).

3. Don’t understand the mandate of the fund managers

This leads to unfair comparisons between funds. This is not only true between different risk-rated funds but also between the same sector or asset-type funds that use different investment styles. Where clients use “best fund rating” reports, this can turn around and burn them badly. If we look at the current reports, the Ninety One Value fund leads the pack by a country mile over the last 12 months and in fact, over the last 10 years. What these figures do not show is the volatility within this fund.

Value funds generally earn their returns very “lumpy”, where long-term returns are achieved over short spurts of fantastic returns. The ranking is also against all equity funds across the equity investment styles. Remember, today’s returns influence the annualised returns over all historical measured periods. The flip side is that long periods of underperformance from these funds are normal. If you do not expect this or understand this, you are going to invest and dis-invest at precisely the wrong times and that will lead to permanent capital losses. Investors do not make the effort to understand the return profile of their portfolios.

4. Change portfolios too often. Short-termism

Short-termism ties in with my comments in point three above. It is important to understand the characteristics of the fund you invest in and remain true to the fund for at least two full cycles of returns. Here, I refer to two periods of gains and losses, not just two years, it may be five or seven years. The one caveat is if there has been a fundamental change in the fund’s management team or the mandate. Often, investor behaviour borders on speculation rather than investing. 

5. Unwillingness to pay fees

Let’s face it: no one likes to pay fees, especially if they cannot be justified. Fees can be a debate that justifies an article in its own right. The bottom line is that fees must be fair to all parties, and the fees must lead to value being added, not only through the returns of the investment but also by the service offered and received in general. If investors do not want to pay fees, but they can achieve a better overall outcome by paying fees for professional services, surely paying fees should not be an issue. This debate will carry on …

6. Misconception of fees and returns

Let me state at the outset that paying fees does not lead to lower returns. This statement is bound to draw some reactions. The only time fees impact returns is when different fees are charged on exactly the same funds with exactly the same returns pre-fees.

This debate and heat under the collar is brought on by passive managers’ marketing campaigns that, at the outset, always state that lower fees lead to better returns. Remember that published returns are after fund manager fees have been deducted. We know that passive funds have lower fees than active funds.

Two of the most vocal-about-fee passive fund managers in the SA space are 10X and Sygnia. With their low fees that lead to the automatic outperformance of higher paying funds (according to them), why then do they rank as follows:

Misinformation and leading people by their noses are my pet peeves. I have no issue with passive funds; we use them regularly. I have a problem with how they are marketed and justified. But as I said in the past, please keep it real. If you state (Sygnia’s favourite opening statement at conferences and open forums) that 70% of active fund managers underperform their benchmark, which is largely true if measured across all registered funds, including broker white label funds, then please also state what percentage of passive managers underperform their benchmarks.

For those readers who don’t know, the answer is 100%. Passive managers literally cannot outperform their benchmark because they invest in the benchmark and charge fees for doing so. The net result is a return lower than the benchmark.

Marketing strategies and the fantastic performance of the S&P 500 (fueled by tech stocks) have led to most “do-it-yourself” investors having a high exposure to passive funds and ETFs. This strategy has served many of them well, especially those who kept funds/ETFs to a minimum. Too many funds/ETFs, again, also dilute the returns of the high-performing passive funds.

Investing in passives is not a mistake, quite the contrary. However, investing in passive funds still requires an active decision. There are many passive funds with different mandates and strategies. The challenge is which one will be the best choice over the next 10 years. 

7. Incorrect interpretation of fees

Investors often make the mistake of adding all relevant costs of individual funds together without proportionally spreading the costs across the funds. You will be surprised how many times I have to explain this in detail, explaining that the total costs are not 11% per year but, for instance, 1.9% per year.

8. Incorrect interpretation and calculation of returns

Various scenarios apply here. First, math lets people down, leading to plain calculation errors. Second, withdrawals are forgotten or ignored. Long-term investments tend to provide a false sense of high returns, as investors deem returns to be higher than they are. Ignoring tax is another culprit. After-tax returns are the actual returns.

9. Choosing funds on short-term past performance. Rearview mirror effect

The most common way for do-it-yourself investors is to choose funds based on recent past performance. People do not realise that a fund could have experienced negative returns consistently for three years or longer, and one year’s strong returns can turn the negative returns into positive returns over that three-year reported period.

Understanding the return profile and characteristics of any fund you invest in is crucial. Determine the maximum drawdown historically and how long the average recovery period was after various downturns. That will at least provide some volatility indication.

Using short-term performance as a measure can lead to buying high and selling low, which is exactly what you must avoid. Often, the suitable funds to invest in are those towards the bottom end of recent past best performers. The ones showing a fantastic recent return more than likely performed from a very low base. They are also unlikely to repeat their fantastic returns and may be set for a downturn.

10. Unwillingness to change portfolios due to CGT triggers

Investors generally have a reluctance and unwillingness towards tax obligations. When it comes to portfolio restructuring, capital gains tax (CGT) is one of the biggest detractors and preventors to changing portfolios, even if remaining in the fund that was proposed to be changed is to the investor’s detriment. Investors shouldn’t let the tail wag the dog. Don’t let CGT be a deterrent to efficient active management when it becomes necessary.

That’s it for now. Next, we will explore another 10 mistakes that I have identified that “do-it-yourself” (and other) investors make.

Take care, keep on investing and be mindful of mistakes …