Making mistakes is a part of life’s imperfections.
So says the song lyrics of British band Level 42.
How true.
Investors can certainly relate as making mistakes is part and parcel of being human.
However, rather than shy away from admitting these mistakes, I believe you should learn from them.
By teasing out valuable lessons from our mistakes, we can learn how to become better investors over time.
And though such mistakes may hurt our pockets, the acceptance of them also means we have a better chance of avoiding them in future.
Best of all, though, is to observe the mistakes that other investors make so that you can avoid the pain of personal financial loss.
Here are five common mistakes that many investors make and how you can prevent yourself from committing them.
1. Investing in debt-laden companies
Companies that heap on excessive debt represent a risky proposition.
We can look back at failed companies such as Ezra Holdings Limited, a player in the offshore support vessel industry, to learn what went wrong.
When times are good, these businesses will bask in the glory of their impressive business achievements.
Surging oil prices more than 10 years ago led to a boom in the oil and gas sector, fuelling increasingly speculative purchases of vessels by Ezra.
In its desire to increase its portfolio of vessels, the company piled on debt like a glutton binging on a buffet.
Investors should remember that a debt-heavy company is entirely beholden to its lenders.
When oil prices subsequently collapsed in 2014, Ezra went into a downward spiral as it could not service its loan commitments.
By March 2017, the company had filed for bankruptcy in the US and suspended trading in its shares, then at an all-time low of just S$0.011.
2. Companies in sunset industries
Another common mistake is for investors to continue parking their money in industries that are way past their prime.
A good example is the compact disc (CD) industry.
When it comes to data storage, CDs were a popular medium used in the 1990s as they could store up to 750 MB of data.
This level of storage was a significant improvement from the smaller capacities of storage media such as zip and floppy disks back then.
However, technology advanced rapidly with the invention of the thumb drive by Trek 2000 International (SGX: 5AB), effectively replacing CDs as the new storage medium.
And even the thumb drive is now being rapidly replaced by cloud storage as more and more businesses migrate online due to the pandemic.
3. Over-promising but under-delivering
It’s easy to get seduced by management promising big corporate moves and impressive acquisitions.
You should, however, remain wary of CEOs that over-promise but consistently fail to deliver.
Spinning a beautiful story is the easy part, while the actual execution is the key factor that separates the great companies from the mediocre ones.
It’s all well and good to listen to management on how they plan to grow the business.
But if the numbers don’t show improvement despite management’s best efforts, then it may be time to shift your money elsewhere.
4. Neglecting the risks
Yet another common problem arises when investors chase returns but fail to appreciate the associated risks.
Greed is the main driving factor here, along with the reluctance to put in the effort required to achieve superior results.
Insufficient research is usually the main cause of risk neglect, as the investor may fail to appreciate the many things that can go wrong with the investment.
A good analogy would be trying to scale a mountain without first researching how to climb it properly and finding out the unique challenges that are associated with the ascent.
When risks do flare up, they can easily cause the investor to lose their hard-earned money.
5. Chasing after high yields
Probably the most cardinal sin of all is the blind chase for high dividend yields.
By “high”, I am referring to dividend yields that hit double-digit levels.
The problem with such high-yield stocks is that they may not reflect the true state of the business.
The reason for the eye-catching yield may be because the share price has already plunged in anticipation of a potential cut in dividends.
Investors who purchase the stock based on what it used to pay may therefore be in for a nasty shock.
In the spirit of prudence, it’s much better to go for businesses that pay out a decent dividend ranging from 3% to 5%.
Sustainability is a more important attribute than high yield and will go a long way in ensuring that you don’t lose money in your investment.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.
