Part of my article series on investing mistakes.
Enthusiasm and zeal can have a downside when investing. For this reason, it’s important to ‘dial it in’ and ensure you exercise control over your investing hobby.
Investing versus collecting
Investing and collecting are similar pursuits and probably engage the same parts of the brain. When you collect objects, you:
- Spend time seeking out new assets to buy
- Are prepared to pay a high value for the asset if it’s justified
- Receive a thrill from owning the asset, yet always want to expand the collection.
There are so many parallels to be drawn with the process of investing.
We too, invest time researching share prices and looking for the next investment opportunity. Whether it’s looking at news online or reading financial journalism in the paper, our brains are constantly looking for a buy or sell signal.
Investors are also prepared to pay a high price for an asset if its price is justified. Shares in Warren Buffet’s Berkshire Hathaway cost $285,000 at the time of writing. This is the market price because of the size of assets and earnings which underpins each share in existence.
Finally, we also get a kick out of owning part of a company. Having access to certain shareholder perks, being able to attend an AGM, or otherwise being more connected with an innovative company which we admire. These are just some of the benefits of being a shareholder.
Why the collecting mindset is unhelpful when investing
Collecting initially looks similar to diversification. An investor with a collector mindset may buy shares in many different companies.
It’s best practise to spread equity holdings over 20 or more companies, so this lines up neatly with best practise.
So, where could issues arise??
Watch out if you feel the temptation to invest in as many asset classes as possible.
I’m talking about going way beyond the basic components of an investment portfolio, such as equities, property, corporate bonds and commodities.
I’m talking about an investor who has managed to squeeze the following into a $100,000 portfolio:
- Equities, including emerging markets.
- Government bonds
- Corporate bonds
- Real Estate Investment Trusts
- Hedge Funds
- Peer to peer lending
- Direct property investment, or land
- Structured products
All in a $100,000 portfolio. That’s only $10,000 per asset class.
When diversification goes wrong
Nobody could deny that the portfolio above is diverse. It’s certainly spreading money around many different asset classes with unique characteristics.
However a collectors portfolio like the above will run into issues:
1. Investment minimums will distort allocations
Usually, an investor will invest in each asset class through a different investment platform.
An investor can choose a stockbroker to buy shares, a peer to peer lending platform to acquire loans, a trading account to take commodity positions, and a property share portal to buy units of property.
Each platform will impose a minimum level of investment, and this could be significant.
In a modest sized portfolio, these can lead to collectors being forced to put a larger % of their total wealth into a high risk platform than they would otherwise like. Is the desire to tick off a different investment really worth it?
2. An overall picture skewed towards high risk
Collectors tend to invest in what interests them. Unfortunately, this tends to be the more exciting propositions which are also the highest risk.
While the portfolio above is ‘protected’ by diversification, it will be weighted heavily towards high-risk options.
Core investments such as shares and bonds should be the cornerstone of a portfolio. However, when the objective becomes acquiring as many kinds of investments possible – this large weighting becomes a barrier, and therefore its share of the portfolio total tends to be eroded over time, until it is simply a minority interest.
This could lead to high returns, but it may also deliver extreme volatility.
3. Fees, fees and more fees
If you’ve read my free investing courses, you’ll know that I am passionate about reducing investing costs. In fact, it’s the first article in my intermediate course offering.
Any cost is essentially a loss. With the aim to reducing these ‘losses’, investors should seek to hold as few investment accounts as possible.
It’s entirely possible to create a balanced portfolio with a single stockbroker/fund supermarket account, therefore that’s what efficiency looks like.
As I described above, exotic asset classes tend to exist on entirely separate platforms which will carry their own platform or account charge. These might be a flat fee, or calculated as a % of assets.
These will stack up as you add more and more accounts to your portfolio. This creates a ‘house disadvantage’, as you now need to generate superior returns just to be able to pay off these fees each year!
Investing is a lot of fun, and ticks many of the same boxes as keeping a collection of curiosities.
However, with some much at stake, we must draw a line and keep our temptations to continuously expand our portfolio under control.
Sometimes, the most effective portfolio is a boring and cheap portfolio with only three fund holdings.
Read more about asset allocation in the best books on the subject in my page: the best asset allocation books.