The 6 biggest mistakes ETF investors make

Investing is counterintuitive for most people. In the popular imagination it’s all about making huge profits as you ditch gold and buy some hot tech firm on the verge of a giant breakthrough in artificial intelligence. But that’s not investing, that’s hit-and-hope speculation. Investing luminary Charles D. Ellis famously compared investing to amateur tennis: because victory goes to the player who makes the least mistakes. Not the player who tries to smash every point – only to keep whacking the ball into the net or out of the court. So what are big mistakes that ETF investors should avoid like the plague? Here’s our ‘what not to do’ list:

1. Attempting to beat the market

Everyone wants to beat the market but hardly anyone can do it consistently. Ironically, attempting to outperform is likely to condemn you to substandard results. Primarily that’s because active investors erode their returns by racking up excessive fees. Nobel prize winner William F. Sharpe demonstrated this in his paper: The Arithmetic of Active Management. Warren Buffett regularly advises people to use funds that track indexes – such as ETFs. Even the active fund professionals who are paid to beat the market persistently fail to do so – as shown by the long-running SPIVA study. Every year some people will beat the market. But the overwhelming majority can’t do it over five or ten years. That’s why you shouldn’t use past performance as a guide to future success. Doing so is typically mistaking luck for skill.

2. Not clamping down on fees

Many don’t realise that small percentage differences in cost can have an outsized, negative impact on your returns over time. Paying higher fees for your funds, broker, and trades moves money from your bank account to someone else’s. And those tiny chips knocked off your results inevitably add up. It’s the opposite of the magic of compound interest. Losing money to high fees negatively compounds. Those small, incremental losses snowball into a large wedge of wealth that you could have had, but sadly gave away to an expensive product. The solution is simple. Spend a little time each year reviewing your choices:

• Can I pick a cheaper ETF that does the same job in my portfolio?
• Is there an ETF savings plan that will save me trading fees?
• Is my broker competitively priced?

3. Not being properly diversified

We all know that diversification means not putting all our eggs in one basket. But it’s easy to overlook that we must diversify qualitatively – against the different types of investing risk we face. You may own thousands of shares if you’re invested in an MSCI World, S&P 500 and Nasdaq ETF. But in a downturn those ETFs typically fall in sync. They’re highly correlated because:

• They’re all invested in equities
• Their indexes are dominated by US firms

Proper diversification addresses the varied economic conditions that can sweep the world:

• Deflationary recessions = investment grade (or better) government bond ETFs
• High inflation / stagflationary scenarios = Inflation-linked bond ETFs
• Growth = global equity ETFs
• Fears of systematic collapse or currency debasement = gold ETCs

With those four points of the diversification compass covered, it’s then worth exploring sub-asset classes to optimise your portfolio. For example, investigating region and risk strategies for equities. Or different average maturities for bonds. Remember that if nothing in your portfolio is causing you pain then you’re probably not well diversified. There is no perfect investment that works all the time. And don’t make the mistake of projecting current circumstances into the distant future. Everyone thought inflation was a thing of the past. But no regime lasts forever. Tech firms get their comeuppance and bonds funds will rise again.

4. Buying high, selling low

You should buy low and sell high, right? So why do we love buying investments whose prices have soared? And why do we sell an ETF after it’s suffered a losing run? Falling prices mean bargains. We know that. But humans are hardwired to follow the crowd. If everyone’s jumping aboard a bandwagon like crypto, then FOMO makes it difficult to resist. We feel like we’re stupid while the rest of the world is (temporarily) getting rich. Equally, the hardest time to get into a market is after a massive crash. But that’s when prices are on the floor. Granted, it’s understandable to worry about an individual stock that may never recover. But the broad markets invested in by ETFs inevitably bounce back. So stay invested when times are tough. Because low valuations amplify your profits when prices pick up. Use best practice investment techniques like rebalancing and cost averaging. They’ll help you buy low and sell high with less interference from the reptilian brain we’re all saddled with.

5. Investing in something you don’t understand

Much pain is inflicted by investments that don't perform as you expect. Perhaps they’re riskier than you realised. Perhaps they act in a surprising way that defeats the point of holding them in your portfolio. Short ETFs are the classic example of a product that doesn’t operate as people think. Long-term investors assume a short ETF will deliver positive returns during a prolonged decline. But these ETFs are specifically designed for making bets on short-term market movements. They’re just not meant for long-term investing. Meanwhile, gold mining ETFs are not the same as physical gold ETCs. Both can be useful but it’s important to know the difference so you get what you pay for.

6. Panic-selling

This is the biggest mistake of all. You lock in losses if you sell during a crash. But those losses only exist on paper so long as you hold tight and wait until the market recovers. Tough out the bad times and broad market ETFs will rebound. Moreover, accumulating ETFs automatically reinvest your dividends at low prices. That juices your recovery just like the cost averaging effect mentioned above. If you are feeling the heat during a downturn then it’s a sign your asset allocation needs to include more lower risk assets. Think about dialling down your equities and upping your government and inflation-linked bonds. If your bonds are making you uncomfortable then consider shorter maturity ETFs in the same category. But whatever you do, don’t sell during a slump.

Bonus: More fails

• Sitting in cash
• Choose an investment horizon that is too short, or none at all
• Not having clear objectives
• Anchoring on unrealistic rates of growth
• Using leverage
• Not investing consistently or delaying investing
• Compound interest Overcomplication – too many small positions in lots of funds
• Reacting to the media
• Chasing yield
• Market timing
• Not understanding risk