From Brazilian rain forest tree bark to celebrity-endorsed slimming plans, the popular media is filled with fantastic ways to lose weight quickly. But despite the hype, most of us know the only path to permanent weight loss is through diligently maintaining a sensible diet and exercise plan over time. Not surprisingly, similar principals apply to investing―there are no get-rich-quick schemes or investments that work, and no financial advisor can foresee the future to make things easy or guaranteed. What does work is less exciting. Long-term investing success rests on avoiding the big mistakes and by carefully following a properly designed investment plan over time and through all market conditions.
To help you on your way to investment success, we've provided a list of the most frequent mistakes we see expats make with their investment portfolios. Avoiding these mistakes will go a long way to boosting your portfolio returns and helping you achieve financial security.
- Giving in to greed and fear
We're all susceptible to greed and fear, whether it's taking a punt on the latest hot Chinese IPO, chasing Australian dollar cash yields or hoarding gold bars to protect against the demise of the world's fiat currencies. And it's no wonder―with entire websites, online newsletters, 24-hour TV channels and racks of magazines touting the latest "can't miss" investment or next impending financial catastrophe, it's easy to fall into a cycle of greed and fear.
Unfortunately, this is the quickest way to investment ruin. Underlying the media's not-so-subtle emotional manipulation is the presumption that the future is predictable. It's not. Evidence has repeatedly shown that investors, as well as self-appointed prognosticators, are no better at foretelling investment outcomes than they are at guessing the winning number on the next roll the roulette wheel.
Everyone assumes that all this emotion-driven buying and selling leads to them earning market or better-than-market returns. The evidence shows that they are not even close. In a recent study by DALBAR, a firm that conducts quantitative analysis of investor behavior, for the period ending December 31, 2010, the S&P 500 returned an annualized 9.14% for the preceding 20-year period, while the Barclays Aggregate (a broad-based U.S. fixed income index) returned 6.89%. Meanwhile, the "average" equity investor only earned an annualized return of 3.83% during the same time period and the average fixed income investor only earned 1.01%. The "average" investor has similarly underperformed during all 20-year and shorter periods throughout the 15 years DALBAR has conducted the study.
The reason is that, in difficult conditions, investors get spooked out of the market. They then wait for strong confirmation before buying again. After large drops like in 2008, individual investors can be out of the markets for years. The result is that investors tend to sell at market bottoms and to buy near market peaks, which guarantees underperforming the market.
- Not paying attention to investment fees
Ignoring investment fees can wreck your portfolio returns. One to two percent may not sound like very much, but it can take a huge toll on your portfolio over time. All investment products charge fees for management, administration, marketing and other administrative costs. In the offshore markets, expats are often paying a front-load fee of 5% or more and ongoing annual fees of around 2%. These fees are even higher for heavily marketed investment-linked insurance schemes where the total ongoing fees can reach 4-5% per year.
When you understand that over the long run your portfolio is only likely to produce annual returns in the range of 6-9% before fees, you can see how much impact these fees can really have. Things look even worse when you consider inflation, which has historically averaged 3-4% (and even higher in the emerging markets). After subtracting inflation, your portfolio is only likely to generate real returns in the range of 3-5%. This is the real growth your portfolio generates in purchasing power to keep up with the rate of inflation.
The fees directly reduce the inflation-adjusted growth of your portfolio. If your portfolio achieves a pre-fee average return of 8% per year and inflation averages 4% during the same time period, your average real return is only 4%. If you pay annual fees on your portfolio holdings of 2%, your real return is now only 2%. This means your portfolio is only growing at 2% on average in real or purchasing power terms. The fee in this case is like a 50% tax on your real investment earnings.
Many expats are paying total fees on their investment portfolio well in excess of 2%, which means it will be very hard to achieve long-term growth in the portfolio.
- Not paying attention to taxes (especially for Americans)
Right up there with not paying attention to fees is not paying attention to taxes. Some expats are lucky enough not to have their offshore investments taxed by either their home countries or countries of residence. Others, particularly Americans, are not so lucky. They will be taxed on capital gains, dividends and interest.
Luckily there are some options to reduce the impact of taxes, such as using available national tax-deferred and tax-exempt savings schemes or tax-deferred corporate pension plans (this does not include high-fee insurance-wrapped investment structures). Additionally, investors can reduce the impact of taxes by selecting appropriate investments that generate tax-exempt interest or pay little in the way of distributions and by managing capital gains.
Used properly, tax management in a portfolio can decrease the drag on investment returns by as much as 1%.
You can't control the markets, but you do have some control over the amount of taxes and fees you pay on your portfolio. Any reduction in these two areas adds to your return without taking any additional risk. This is free money.
If your portfolio is earning a pre-tax, pre-fee return of 8% with inflation at 4% and you are paying 2% in fees on your investments and another 1% to taxes, your real return is only 1%. If you can reduce your fees to 1% and the tax burden through proper management by 0.5%, you will have increased your real return from 1% to 2.5%. While this doesn't sound like much, this can increase the value of the portfolio by more than a third over a 20-year period.
- Currency mismatch
Most expats maintain a bias towards their home country. They tend to think in that currency and to overweight investments in their home country. For expats on short-term overseas assignments who intend to return to their home country, sticking to a home currency can be OK. But for long-term expats or those planning to permanently remain overseas, this can be a big mistake.
The goal of any investment portfolio is to fund future expenses. For many expats, those expenses will be denominated in currencies other than their home currency. As we are all aware, currencies can be notoriously volatile. Having a big mismatch between the currencies embedded in your investment portfolio and the currency of your expenses can be a disaster. If your child plans to attend a university that charges in EUR, then you should ensure that the bulk of the assets intended to fund those college expenses are EUR assets. You don't want to be holding USD assets while the USD drops by 10% against the EUR just before your child getting ready to head off for university.
- Putting it off
Procrastination is just as devastating to the success of your investment strategy as any of the above mistakes―maybe more so. It's easy to let life get in the way and assume we'll get to it later. The problem is that time rarely comes. This is particularly insidious for investments, as much of the future value of your portfolio is based on the compounding of returns over time. Devising and contributing to a properly designed portfolio early and consistently has a far greater impact on ending portfolio values than contributing a greater amount later on. Also, with today's uncertain job security, later on may never come.
You may have heard the story of the twins, Bill and Phil. At age 19, Bill starts saving and investing US$5,000 per year in an investment portfolio that earns 8% per year annual compound return. He stops contributing after just eight years and lets the investment grow until he retires at age 65. Phil doesn't get started until age 31, but then contributes $5,000 per year to an investment portfolio that similarly earns 8% per year compound return. Phil contributes for 35 years until he retires at age 65. Who saves and contributes more? Who has a bigger portfolio at retirement?
Phil saves considerably more-$5,000 x 35 years = $175,000 in total, while Bill only saves $5,000 x 8 years = $40,000. Yet Bill still has more at retirement ($1,108,184) versus Phil's $865,350, simply because Bill got started earlier.
Along with your savings, the returns you earn on your investment portfolio largely determine your ability to achieve your financial goals and financial security. You can't control the market, but you can control many other ways to increase your portfolio returns and reduce risk. Avoiding the mistakes above will go a long way to boosting your portfolio return and putting you on the path to financial security.
About Creveling & Creveling Private Wealth Advisory
Creveling & Creveling is a private wealth advisory firm specializing in helping expatriates living in Thailand and throughout Southeast Asia build and preserve their wealth. Through a unique, integrated consulting approach, Creveling & Creveling is dedicated to helping clients cut through the financial intricacies of expat life, make better decisions with their money, and take the steps necessary to provide a more secure future. For more information visit crevelingandcreveling.com.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.