Investment rules for your ISA
1) Buy for the long term: Trying to move in and out of the market in line with market sentiment is usually a speedy way ensure you buy at the top and sell at the bottom – the exact opposite of what you should be doing. Every investor is vulnerable to those familiar investment emotions 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 blown about by the whimsy of the market.
2) Don’t neglect the costs of your investments: Whether you are buying active or passive funds, you need to get value for money. Is an active manager delivering you suitably higher returns for the fees they are charging? Does a passive fund have the most competitive management charges among its peer group? Just because something is cheap does not mean it is delivering good value for money.
3) Don’t buy at the wrong time…The price of an investment will change over the course of a market cycle, according to the law of supply and demand. Thus, the more popular an asset is, the more expensive it becomes and the more chance you have of losing money if you buy in at that point – and vice versa. For example, everyone thought Tesco was safe as houses five years ago, and the share price was over 400p. Now, everyone thinks it’s a basket case and its share price is under 200p. Clearly, five years ago, at the height of its popularity, was the worst time to buy.
4) Seeking out a good fund manager is worth the effort: A good fund manager can add significant value over time. Over the year to 25th September, for example, the FTSE 100 index has risen by just 2 per cent. Over the same period, the average manager in the UK All Companies sector has returned double that, and the best managers have made double digit gains.
5) Diversification is “the only free lunch in finance”: So said Nobel prize-winning economist Harry Markowitz. If investors knew for certain what asset classes were going to rise in value, they could just invest there and life would be easy. Investors do not know – at least not with any certainly – so they need to avoid putting all their eggs in one basket and spread their risk across different asset classes and investments.
6) If you don’t understand it, don’t buy it: History is littered with ‘investment opportunities’ that have tried to bamboozle investors with complexity. Enron? Madoff? Beware of the emperor’s new clothes syndrome. If you don’t understand it, don’t buy it.
7) You don’t get something for nothing: The highest rewards in investment tend to go hand-in-hand with the highest risks. So, while you will not actually lose any money by putting it in a bank account, you will not see much of a return either. Similar thinking applies to the stockmarket where a large ‘blue-chip’ company will have to pay less by way of a dividend to encourage people to invest than a smaller company on a less sure financial footing. If it sounds too good to be true, it almost certainly is.
See our free ISA guide for more tips.