How To Avoid These 7 Deadly Sins

JOHN HEINZL

We all make investing mistakes from time to time. We let our emotions take over. We get too fearful, or too greedy. We focus on short-term returns when research shows that investing is a marathon, not a sprint.

But while every investor is different, some mistakes occur with alarming frequency, financial experts say. In good times, these blunders often go undetected, but when markets implode, they can cost investors big time.

Based on interviews with financial planners, money managers and investor advocates who shared real-life examples from their own practices, Investor Clinic presents the seven deadly portfolio sins - and how to avoid them:
 

1. Ridiculous risk


Garth Rustand, a former broker who runs the Investors-Aid Co-operative of Canada in Vancouver, sees many investors taking on far too much risk for their age or level of sophistication. One recent case - in which the investor's losses were magnified by leverage - stands out.
"She was 59 years old and wanted to retire in two years. Her entire portfolio was in equities, plus the adviser had her go out and borrow a third of the value of the total portfolio to invest in more stock," he says. "So then the meltdown hit and she just got clobbered."
Solution: Maintain an appropriate mix of equities and fixed-income investments, and don't borrow to invest unless you understand the risks and can afford a hefty loss.

2. Flagrant fees

Paying high fees may be the most widespread portfolio error, and it can put a massive dent in long-term investing returns. "Many have no idea what they are paying. Nor did they have the inclination to ask," says Derek Moran, president of Smarter Financial Planning Ltd. in Kelowna, B.C..
A related mistake is buying mutual funds with large deferred sales charges. Also known as back-end loads, DSCs are charged if the investor sells a fund before a certain number of years - usually six or seven.
Solution: Ask your adviser how much you're paying in fees annually and, if it strikes you as too high, start considering your options. For mutual fund investors, look up the fund's management expense ratio on websites such as globefund.com or morningstar.ca.

3. Diworsification

Not to be confused with diversification, we're talking here about portfolios that have far too many holdings invested in the same companies or industries. Owning a bunch of overlapping mutual funds that charge hefty fees is one of the most common diworsification pitfalls.
"The worst I've seen is an individual who had about $4-million and it was in 70 or 80 mutual funds. Can you believe it?" says Warren MacKenzie, president of Second Opinion Investor Services in Toronto. The problem arises, he says, because advisers earn a commission for steering clients into particular funds, or because investors try to chase hot performers.
Solution: Invest in a handful of complementary funds covering different sectors or countries. Better yet, use low-cost mutual or exchange-traded funds that track broad indexes. Investors with large accounts can cut their costs further by diversifying with individual stocks and bonds.

4. Bogus benchmarks

Constantine Kostarakis, portfolio manager with Pfiffner Management Inc. in Montreal, was reviewing a new client's statements when he noticed something odd: The previous firm had compared the client's returns to the consumer price index, not to an index that tracks stocks or bonds.
Naturally, the client's performance looked pretty good compared with the small rise in the price of food and clothing that year - which may have been precisely the point. "Lesson learned: Make sure to compare your investment performance on an apples-to-apples basis," he says. For a Canadian equity fund, for example, the proper benchmark is the S&P/TSX total return index.
Solution: Globefund.com and morningstar.ca list the comparable index returns alongside performance data for mutual funds.

5. Herd mentality

Mutual of Omaha's Wild Kingdom isn't the only place you'll observe a large group of mammals stampeding in the same direction. Investors do it all the time when there's a fast-rising stock or fund - often just before the price tumbles.
"Investing in a mutual fund or stock when it is 'hot' will almost always lead to buying at the wrong time. When everyone you know is buying a particular stock or getting into the stock market, it's probably time to get out," Mr. Kostarakis says.
Solution: If your heart is racing with anticipation as you prepare to hit the "buy" button, take a walk and think about whether you really want to pull the trigger.

6. Lax on tax

Mr. MacKenzie of Second Opinion sees too many portfolios where tax consequences have been ignored.
"There are things you can do that will save you quite a lot of tax," he says. "It's as simple as holding your bonds and interest-bearing things inside your RRSP and holding your stocks outside." That's because interest is fully taxable outside an RRSP, whereas dividends benefit from a juicy tax credit.
Solution: Read up on taxes and investments on websites such as http://www.taxtips.ca. If you find that too painful, consult a reputable tax adviser.

7. Uh, explain that again?

Mr. Rustand of the Investors-Aid Co-operative says many products sold to investors are of questionable quality because of high fees, excessive risk or complex structures. His list of products to avoid includes labour-sponsored funds, principal-protected notes, segregated funds and emerging market funds.
"There's very little product out there that is good for consumers. Most of it costs too much or is difficult to understand," he says.
Solution: Keep it simple by investing in index mutual funds, index ETFs and low-fee dividend mutual funds.

(c) 2009, The Financial Post, Used by Permission