The top 10 investment mistakes to avoid
1. Taking a short-term view
History suggests the stock market is the best way to grow wealth over the long term, easily outpacing interest rates on cash. However, don’t expect stellar returns from day one. Significant market falls are a natural part of investing and, sadly, notoriously difficult to predict. It is worth remembering that the longer you invest for the greater your chances of a positive return, which is why most people suggest you should only invest in equities if you are committed to do so for a minimum of five years.
2. Timing the market
Buying low and selling high is the aim of traders the world over. However, investing is not the same as trading. With investing the aim should either be to use time and patience to multiply your wealth over a long period, or to generate an income from a capital sum. Both these aims are usually best met by staying invested rather than habitually trading in and out of assets. To do so would interrupt the flow of income or undermine the benefits of “compounding” returns over time. By all means revisit your strategy and asset allocation from time to time, but remember that timing the market is tricky and you need a very good reason to sell up completely.
3. Taking the wrong level of risk
Getting the balance of risk and return right can take time and depends on a number of factors – investment goals, timescale and the requirement for income. It will also be shaped by how much volatility (the extent of ups and downs) you are prepared to accept – and this could change over time. Take too little risk and your capital may not grow as much as you need it to; for instance, having a large weighting to cash or government bonds in your pension in your twenties and thirties would seem a wasted opportunity. However, take too much and you could become a victim of market volatility. This is particularly relevant for investors looking to cash in or draw upon their investments in the short term.
4. Getting diversification wrong
Diversification is the cornerstone of sensible portfolio management. Having all your eggs in one basket might make you a fortune, but it might lose you one too. A related mistake is unwittingly having too much of a portfolio facing in one direction. For instance, investing in mining funds and Chinese equities may offer little diversification. Many companies in the mining sector are reliant on Chinese growth, so it may mean the two areas rise and fall virtually in tandem. Similarly, watch out for funds that overlap in terms of style or holdings, or which have large stakes in shares you already hold. While diversifying is sensible there is no point having several funds in the same sector doing the largely same thing. Strike a balance between backing your best ideas and having a sensible spread.
5. Buying last year’s winners
Buying an investment just because it is going up might sound silly, but this is basically much what “momentum” investors do. However, doing so without having an idea of why, or whether it offers value relative to similar assets, is foolhardy. In particular, don’t buy a fund just because it is top of its sector over a short time period. A stellar period of performance can easily be reversed, and it can often pay to monitor the investment before buying in. Also take into account longer term performance and, in particular, returns over discrete years to give you an idea of how the fund has behaved over time.
6. Being attracted to the highest yielding investments
Investors are naturally attracted to investments producing a high level of income. However, it is also a warning sign. There is likely to be a very good reason why an investment yields so much. Is it a share where the dividend is likely to be cut? For bonds, higher yield means higher risk – there is more chance of default and capital loss.
7. Not taking a profit
There is nothing wrong with banking gains if an investment exceeds your expectations and grows to represent a much larger slice of your portfolio. Use profits to diversify, or to rebalance to areas that appear to offer better value. In particular, do not become emotionally attached to investments no matter how well they perform for you. Critically reassessing the investment regularly should help.
8. Not paying attention to charges
Charges can have a considerable effect on your investments over time. Overtrading can result in incurring needless stockbroking fess, while investing in active funds with high charges but similarly positioned to the benchmark can result in a drag on performance. I favour either truly actively-managed funds with a defined investment philosophy and robust process, or else low-cost passive funds that provide simple and effective solutions for investors’ asset allocation needs. You will find examples of both of these on our Foundation Fundlist of preferred investments across the major sectors.
9. Not using tax shelters
It makes sense to take advantage of your annual tax wrappers such as ISAs. Even if this isn’t relevant to you in the shorter term your tax position may change in the future. Many investors have built ISA portfolios worth hundreds of thousands of pounds, a sizable nest egg sheltered from capital gains tax and income tax. The 2016/17 tax year ISA allowance is £15,240 and there is no extra cost involved with investing in an ISA wrapper with Charles Stanley Direct.
If you are investing for retirement then a pension is likely to be an even more tax efficient route as it is possible to receive tax relief on contributions of up to 45%. However, an ISA provides more flexibility to access money when needed. Tax treatment depends on your individual circumstances and may be subject to change in the future.
10. Losing track
If you have built up your portfolio over a number of years it can be difficult to keep track of everything. Maintaining a spreadsheet can help with this, as can consolidating as many of your investments as possible with a low-cost platform such as Charles Stanley Direct.
Rob Morgan is a pensions and investments analyst at Charles Stanley