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Ten investment mistakes and how to avoid them

 
Rob Morgan
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Constructing a well-balanced portfolio takes careful planning. Rob Morgan outlines how to avoid ten common mistakes investors make. (Source: Thinkstock)

Holding too much cash

Having cash reserves is important. Most people need a ‘rainy day’ fund to cover unforeseen events, and for saving towards shorter term goals cash is appropriate because it offers security of capital. Some investors also like to hold some cash to take advantage of opportunities in the market as they arise. Yet holding too much for long periods can be a mistake. Inflation can gradually eat away at the spending power of cash and other assets such as shares are likely to do a better job of growing wealth over the long term. 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.

Timing the market

Buying low and selling high is often the aim of traders. However, investing is not the same as trading. With investing the objective 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 regularly moving 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.

Taking the wrong level of risk

Getting the balance of risk and return right can take some consideration 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 low risk areas 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 at just the wrong moment. This is particularly relevant for investors looking to cash in or draw upon their investments in the shorter term.

Getting diversification wrong

Diversification, owning a variety of assets whose returns are independent of each other, 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 Latin American equities may offer little diversification. Both tend to be reliant on the commodities cycle, so it may mean the two areas rise and fall at the same time. 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.

Buying last year’s winners

Investors are often attracted to top performing funds or shares. However, buying in 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.

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.

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.

Not paying attention to charges

Charges can have a considerable effect on your investments over time. Overtrading can result in incurring needless stockbroking fees, while investing in active funds with high charges but similarly positioned to the benchmark can result in a drag on performance. We 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 on the Charles Stanley Direct Foundation Fundlist of preferred investments across the major sectors.

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 2018/19 tax year ISA allowance is £20,000 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.

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 record, for instance via 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.

This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal.Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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