DIY investors are at risk of falling into a number of pitfalls, which can be dangerous. They include:
Chasing past performance: one of the biggest human failings when it comes to investing is choosing last year's winner. DIY investors fall into this trap all too often. Cynics may think this argument is fuelled by fund managers trying to convince us to buy their fund. But independent organisations such as Standard & Poor's say the same. Ways to guard against this failing include looking for factors over and above past performance such as low fees and longevity of managers. Also, does the fund in question have one management "star", or a team that follows certain investing rules diligently?
Ignoring asset allocation: DIY investors sometimes forget to build their portfolios from the top down. That is to set an asset allocation that suits their needs and fill the portfolio with investments that fit that allocation. Some investors have little or no diversification because they have taken a passive approach to investments sometimes inheriting them, or putting all their money in one sector such as residential property, or New Zealand shares.
Failing to diversify: closely related to ignoring asset allocation, failing to diversify can be downright dangerous and there can be a price to pay. If the one sector or investment you've bought performs poorly – as they all do at times – you could lose growth opportunity. If that investment or sector crashes and burns, you've lost everything. This does happen. Just look at the finance companies or CDOs.
Buying high and selling low: buy low and sell high is such a no brainer that it's surprising that a huge chunk of novice investors do the opposite. The reason is human psychology. People want to put their money in investments they see others investing in – lemming like.
Picking shares without a view to the economy: a Motley Fool article was the inspiration for this blog and it's worth reading. The argument is that by simply choosing shares (or any investment for that matter) by researching the company "bottom up" is dangerous because it fails to take in macroeconomic factors.
Cold calling: I'm sure I'm preaching to the converted with RaboPlus customers, but buying ANYTHING being sold by a cold caller is just downright dangerous. I make a point of always attending cold callers' seminars or inviting them to present to me and I have NEVER been offered anything worth buying. At best they were poor investments, at worst dangerous products such as Blue Chip properties or scams. If it were such a good deal on offer they'd have investors queuing up to buy the product.
Failing to ditch the duds: we've all made mistakes when picking individual investments – even investment advisers do. Good investors ditch the duds and use the money to invest in better opportunities. If you always hold and pray, you'll end up with an eclectic bunch of also-rans in your portfolio. Review your portfolio at least once a year – it's dangerous not to.