Five investing mistakes to avoid

In our view, here are two key ingredients to successful investing: the ability to measure probabilities properly and being able to control your emotions effectively. But here’s the tricky bit about investing―the probabilities are often in your favour when emotions are running high, and uncertainty is heightened.

The first step toward avoiding investing mistakes is to be aware of them. Here are five common pitfalls that often find their way into our conversations with investors. 

1 Hubris

Hubris—or overconfidence bias in investing—is an emotional bias where investors overestimate their investment skills. It often leads to poor investment decisions at the expense of long-term returns.

Why do investors tend to become overconfident? Here’s a little context: historically, markets have trended higher in the long run. The S&P 500 Index, for instance, has been positive nearly 90% of the time on a rolling five-year basis over the past 50 years. This, along with bull markets, do a wonderful job of pumping up our egos, making investors believe that their investment acumen is superior.

In fact, historical market returns show that rarely do yesterday’s market champions become tomorrow’s winners. Even if an investor were able to correctly identify the “winning” equities one year, it doesn’t mean that the same group of equities will be able to repeat their winning streak year after year.

Identifying winners requires thoughtful research and analysis—it may not have as much to do with our innate investment skills as we’d like to believe.

To borrow a sports analogy: hubris can also lead investors to believe that they can hit home runs and should focus on hitting home runs when, in truth, they only need to hit singles. What we’re trying to say is that investors tend to equate investment success with large sums of money, but that's not necessarily true. On the contrary, a series of small, smart investment choices can potentially lead to healthy returns in the longer term through the compound effect.

The tax-free savings account (TFSA) is a good example that we can use to illustrate how compounding works. It’s a savings program introduced in 2009 that can also function as an investment vehicle that enables Canadians to invest in a tax-free manner.

Investors who had maxed out their annual TFSA contribution limit had invested a total of $95,000 since the program started. If they had invested in the S&P 500 Index, the S&P/TSX Composite Index, and the MSCI World Index, their investments would have grown to $277,213, $160,491, and $202,823, respectively, as of year-end 2024. To us, it’s proof that you don’t need to focus solely on home runs to win big. Small, consistent wins can do the job just as well. 

2 Impatience

Patience is a virtue. That said, in a world that prioritizes convenience and instant gratification, the concept may seem increasingly at odds with the way we live. When it comes to investing, however, patience remains an important trait, and impatience, a bane.

In an ideal world, investment returns would be distributed equally throughout the year—this would feed into our desire to see constant positive outcomes. But that’s not how investing works in real life. For evidence, look no further than returns for Canadian bonds in 2024.

An investor who was fully invested in Canadian bonds throughout the year would’ve earned 4.2% by year end. But did you know that returns for the asset class had pretty much stayed flat for half the year? If the investor had decided to exit his or her position during the summer, the investor would’ve missed out on the vast majority of the gains.

This is why it’s important to be fully invested—missing the market’s best-performing days can hurt returns. On average, there are roughly 250 trading days a year. If investors weren’t invested on the five days when the market turned in its best performance during the year, their calendar year return could have fallen from 4.2% to essentially flat. The difference can be substantial. In 2023, the difference was more materials with a difference of nearly 6% by missing the best five days.

There may be some investors who believe their returns would be higher if they missed the market’s worst-performing days. This may seem logical, but it doesn’t take into account the fact that the best- and worst-performing trading days tend to occur in quick succession. It’ll take an extraordinary amount of foresight and precision to be able to get in and out of the markets precisely to sweep up all the gains and avoid losses. It’s not impossible, but highly improbable. 

3 Anxiety

Investing is a probability-based decision. Historical evidence suggests that the odds of investment success are in an investor’s favour when allocating capital to an asset class (e.g., stocks) that had just experienced a significant price correction; so far, so logical. In real life, however, emotions come into play. Investors are often paralyzed by fear and anxiety when the price correction occurs and tend not to take advantage of opportunities that emerge.

That said, it’s important to remember that corrections are normal. They’re evidence of a normal, functioning market. While the gnawing sense of anxiety sparked by market corrections may fuel the sense the odds are stacked against you as an investor, historical data—using the S&P 500 Index as an example—provides an interesting perspective: over the long term, the index generates positive returns more often than negative ones. 

What this implies is that it’s important to stay invested. We like to say that when it comes to investing in equities, it’s really more about time in the market than timing the market. Crucially, as an investor’s investment time horizon increases, the odds of investment success tend to improve materially. For example, for any five-year period dating back 50 years, the odds of the S&P 500 Index being positive is 90% of the time.

There’s always a reason to want to sell or wait to get in, but in our view, one of the biggest hurdles to investment success is the ability to stomach the roller coaster ride.

4 Fear

It’s common knowledge that the CBOE Volatility Index (VIX)—or the fear index—is a gauge of stock market volatility or the level of uncertainty faced by investors. What’s perhaps less well known is this: an uncertain trading environment in the near term can often lead to better investment outcomes for those who are able to take advantage of changing market conditions. 

We’ve analyzed the six-month, one-year, and two-year forward returns of the S&P 500 Index when the VIX is at various levels, using the 30 level as a point of reference since it’s widely accepted that the level of fear in the market is considered excessive when the index is above this level.

What we’ve found is that between 1990 and 2024 the average forward returns for U.S. stocks in the three time periods we studied are highest when the level of fear in the markets is considered excessive. Interestingly, one-year forward returns exceeded 20% when the VIX reading is above 30, more than double the forward returns achieved in the same time frame when the fear index is below 30.

There’s perhaps a lesson to be learned here: when it relates to investing, being fearful can come at the expense of generating returns, but taking advantage of other’s fear can potentially yield returns. 

5 Cynicism

There’s a tendency among investors to believe that they’re more likely to experience investment losses than gains, and that outsized returns are rare. Once again, this is understandable, but data suggests this sense of cynicism is unfounded.

Over the past 55 years, the broader U.S. stock market—as measured by the S&P 500 Index—has posted substantial positive calendar year returns since 1970 nearly 80% of the time. Impressed yet? It gets better: during this period, the index returned more than 10% nearly 60% of the time. And of these, nearly 40% of the time the calendar year returns have been greater than 20%. 

Here’s another set of data that should go a long way to quelling cynicism. While investors are often wary of bear markets, the one thing we can count on is that every bear market has ended with the arrival of a new bull market. Crucially, since 1950, each of those bull markets has been stronger and has lasted longer than the preceding bear market.

Conclusion

Investments don’t come with guarantees and may not be for everyone. That’s why there are professional advisors whose job is to help investors navigate financial markets and plan for the future. The five common investing mistakes that we’ve highlighted can also serve as a guide to help shape your approach to investing.

There’s an ancient proverb that says, “The best time to plant a tree was 20 years ago. The second-best time is now.” Like a tree, investments need time to grow. Markets may continue to be volatile but putting money to work as early as possible will allow the benefits of compounding to take effect. Don’t leave it too long.