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Seven investment mistakes and how to avoid them

Getting started in investing can sometimes seem like a maze. Here’s how to avoid some common mistakes investors make.

| 6 min read

There’s a lot to think about when you start investing and several traps you can fall into. Here are some of the common mistakes and how you can help avoid making them.

Trying to time the market

Investors often get hung up on ‘when’ to buy into an investment, but it can be very difficult to choose an entry point and often it’s a waste of time to second guess the direction of markets in the short term.

When 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, including 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 less dependent of each other, is the cornerstone of sensible investing. Having all your eggs in one basket might make you a fortune, but it might lose you one too. Combining share investments with others that are exposed to different risks such as bonds has been highly effective historically.

Be careful of unwittingly having too much of a portfolio facing in one direction. For instance, investing in a US fund and a technology fund could mean you are doubling up on exposure to one sector due to the concentration of the US market towards the big tech companies such as Amazon. That’s not been a bad thing in the recent past, but imbalance can lead to lumpier returns than a more diversified approach. You shouldn’t be too reliant on certain stocks or areas, though a portfolio shouldn’t become a ‘stamp collection’ of hundreds of holdings – that’s taking diversification too far.

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, isn’t sensible. 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. Also, consider longer-term performance and returns over discrete years to give you an idea of how the fund has behaved over time.

Being attracted to the highest yielding investments

The ‘yield’ is the annual income an investment provides expressed as a percentage of its value. For instance, an investment worth £1,000 that provides £50 of yearly income has a yield of 5%. Investors are often naturally attracted to investments producing a high level of income. However, it can also be 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 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 funds with high charges can impede performance. Low-cost ‘passive’ funds that aim to mimic the performance of a certain index is one way to keep charges down and provide a simple but effective way to invest.

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.

In this (2020/21) tax year ISA allowance is £20,000 and there is no extra cost involved with investing in an ISA compared to a non-ISA Investment Account. As well as contributing lump sums you can add to your ISA monthly, which can help smooth out uneven stock market returns.

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.

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Seven investment mistakes and how to avoid them

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