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10 things to bear in mind when investing

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Thinking of taking the plunge with stock market investment? Here are some tips to bear in mind.

1) You don’t get something for nothing

The highest rewards are generally associated with the highest risks. Investment theory suggests investors have to be paid more to encourage them to invest in areas where there is a greater risk of losing money. So, an investor may get paid very little for investing in bonds issued by a developed world government where there is little risk of that government defaulting, but a lot more for an emerging market government where the risk of it not paying its debts is higher. The same is true in the stock market.

2) Investment is personal

The right fund for your brother-in-law, accountant, cabbie, may not be the right fund for you. You will have different financial goals, different levels of wealth and, perhaps, a different emotional response to taking risk. Some people are born risk-takers and can deal with short-term losses, for others that is far too stressful. Make your own decisions.

3) Buy for the long-term

Trying to move in and out of the market in line with market sentiment is often a sure-fire way to buy at the top and sell at the bottom. Every investor is vulnerable to being swayed by the market mood and its periods of fear and greed. If you decide an investment is right for you and nothing happens to change that view, hold on for the long-term and do not be buffeted by the market’s winds.

4) Try not to overpay

Investments become more and less expensive throughout a market cycle – an expensive investment is risky, whether it is a government bond or an emerging market equity, so investors always need to have an awareness of whether the asset they are buying has had a long run of outperformance (and may therefore be expensive). Buying at the top of the cycle is surprisingly easy to do. It can feel intuitively right to follow lots of other investors into a stock or fund, but the results can be painful.

5) …and know when to say goodbye

If a holding has performed particularly well or particularly badly compared with its peers, it should always prompt a review. For weaker holdings, it is worth asking whether something has changed and whether you need to cut your losses and reinvest in a better-quality alternative. Where a holding has performed particularly well, it may now be expensive relative to its peers and due for a correction downwards.

6) Costs matter, but value matters too

Whether you are buying active or passive funds, you need to ensure you are getting value for money. Is an active manager delivering higher returns for the fees he/she is charging? Does a passive fund have the most competitive management charges among its peer group? It is not necessarily about looking for the cheapest option, but the one that is delivering good value for money.

7) Seeking out strong fund managers is worth the effort

A good fund manager can add significant value over time. For example, over the past year the FTSE 100 is up just over 7%, but the top managers in the UK All Companies sector have delivered a return of around 4x that over the same period. That said, even the best managers will have periods of weaker performance. It does not necessarily mean they have become bad managers.

8) Diversification is ‘the only free lunch in finance’…

That’s according to Nobel prize-winning economic Harry Markowitz. If investors knew what was going to go up, they could just invest in one asset class and it would be easy. They don’t, at least not with any certainty, so they need to spread their risk across different asset classes and investments, ensuring that not all their eggs are in one basket.

9) If you don’t understand it, don’t buy it

Warren Buffet has expressed no regret that he missed out on the gains to be made from Microsoft. He didn’t understand it, he didn’t buy it and he believes that this philosophy has saved him more than it has cost him over time. History is littered with failed companies where management tried to bamboozle investors with complexity – Enron stands out.

10) It is worth it in the long-term

For the most part, if you are sensible and pragmatic, investment should provide you with a more secure future.

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