Bert Clark Success in Simplicity: Steering Clear of Common Investment Pitfalls

"Occam's razor" is a useful rule of thumb for many aspects of life, including investing. It asserts that the simplest explanation of things is generally the most accurate and useful.

In the context of investing, applying this principle suggests avoiding the most common pitfalls to achieve success. Afterall, in simple terms, what is success other than not failing? Unfortunately, many investors pursue more complicated strategies and do not spend enough time just trying to steer clear of the most common investment pitfalls.

Over the last five years, the Canadian dollar total returns of the ACWI (all country world index) were 108%; the S&P 500 were 131%; and S&P TSX were 119%. With broad market returns like these, why doesn't investing often feel easier for many investors?

One explanation may be that many investors are often too focused on trying to generate better returns through difficult-to-execute strategies, like correctly picking winners, making concentrated bets or timing markets.

For many investors, the path to success might be more straightforward, focusing on avoiding some of the most common investment pitfalls, each of which is discussed below:


Trying to Pick Winners to "Beat the Markets"

One of the most common investment pitfalls is focusing too much on trying to beat the market by overweighting or underweighting individual stocks within an index. This is a hard thing to get right and often leads to investment results that are worse than the index. For example, S&P's SPIVA Scorecard has documented just how few active fund managers beat their indexes, across most market segments and timeframes. Investors need to ask themselves whether they have investment advantages that would allow them to outperform most professional fund managers. If not, trying to pick winners is more likely to reduce, rather than enhance, their returns.


Trying to Time the Markets

Another common investment pitfall is trying to "time the markets" by buying and selling based on predictions of near-term market events. Identifying when capital markets will rise or fall is very difficult to do. As Keynes said: "The market can stay irrational longer than you can remain solvent." Morningstar has documented how most mutual fund investors actually earn less than the funds they invest in, because they invest and withdraw funds at the wrong times. Like stock picking, market timing is an unlikely path to investment success for most investors.


Ignoring Costs

Many investors also don't devote enough effort to reducing costs. Costs materially impact net returns, and they are one of the few things investors have some control over. Advisor fees, active management fund fees and capital gains taxes can eat up a significant portion of investors' returns. Investors should ask themselves if their advisors or actively managed funds are outperforming the relevant index or simpler investment strategies. They should also ensure they are avoiding unnecessary buying and selling, which triggers capital gains taxes and reduces the power of compounding returns, which Einstein humorously called "the eighth wonder of the world." For many investors, the potential to enhance net returns by reducing costs likely exceeds the potential to do so through stock picking or market timing.


Big Bets

Finally, sometimes deliberately and sometimes inadvertently, investors make "big bets": they allocate a large percentage of their portfolio to an individual investment, market segment or asset class. Unfortunately, there are no “sure bets,” so big bets are risky business. Any individual investment, market segment, or asset class can go sideways or down, and for a long time. There are many examples:

  • Once dominant companies like Nortel (at one time the most valuable company in Canada) and General Motors (for years, the largest U.S. company) went bankrupt;
  • The Japanese market peaked in January 1990 (when it represented 32% of the ACWI index) and took 34 years to reach the same level (it now represents just 5% of the index);
  • The Nasdaq dropped in March 2000 and took 15 years to regain its peak;
  • The European bank index is still below its pre-GFC high;
  • The FTSE Nareit Office Reits index has fallen by 33% since its peak five years ago in March 2020.

None of the things listed above are niche strategies or exotic investments. That is the point. Very conventional companies, market segments and asset classes can underperform, by a lot and for a long time. So, an outsized allocation to any of them at the wrong time will materially and negatively impact an investor's long-term returns. Big bets can hurt.

Today, even investing in a conventional index can result in an unintentionally big bet: 65% of ACWI companies are U.S. and U.S. dollar denominated companies (up from 41% 15 years ago), just 10 companies represent 39% of the S&P 500 (one of the highest concentrations ever recorded); and 33% of the S&P TSX companies are financial institutions.

Today, perhaps more than ever, avoiding big bets requires diligence and a lot of hard work. Many conventional indexes and strategies will draw investors into very concentrated positions. Diversification is worth the effort to prevent the kinds of outsized negative impacts that can result when a single investment, market segment or asset class performs poorly. These things regularly happen.


Lacking a Range of Safe Harbours

Avoiding big bets is just as important when it comes to investments that are intended to serve as safe harbours. There are a range of investments that can serve as safe harbours to offset the impact of regular drawdowns of higher returning but more volatile asset classes like equities, and to avoid having to sell these assets when they are down. Safe harbours include certain currencies (like the U.S. dollar, Swiss Franc and Japanese Yen) and various government bonds (nominal and real, short, mid and long, U.S. and Canadian). However, not all potential safe harbours work equally well in all crises. For example, in 2020, U.S. long dated Treasuries rallied 9.5% and served as a strong offset to losses in equities, but in 2022, U.S. Treasuries fell 15%, providing no protection from equity losses. There is no single safe harbour that works in all down markets. The key is to target broad downside protection – and not make a big bet that one specific currency or bond will work in all crises. Each crisis is unique.


A Disciplined Approach All Investors Can Benefit From

It is not just retail investors who can benefit from avoiding the most common investment pitfalls discussed above. Even the most sophisticated institutional investors would be well-served by focusing on avoiding common investment pitfalls. And, as it happens, they are often well placed to do so. Scale allows large investors to access and manage a portfolio consisting of a diversified range of public and private asset classes, across geographies, in different currencies and market segments, all on a cost-effective basis. While scale can often enable large investors to outperform in select areas, the more reliable advantage scale gives investors is the ability to build better diversified portfolios, at lower cost.

Size and scale matter, but only if investors focus on steering clear of some of the most common investment pitfalls: chasing outperformance where there is a low probability of success; trying to time markets; incurring unnecessary costs; making big bets; and lacking a range of safe harbours. Simple, but not easy. All investors can benefit, but discipline is required.