Six investment pitfalls beginners must avoid

If you are just getting started in investing there are a few things you should learn about first.

| 7 min read

Investing is a necessity if you want to grow your money over time – the spending power of cash tends to go backwards because returns on it aren’t enough to keep up with inflation. But if you are just getting started in investing, taking a ‘DIY’ approach there are a few things you need to learn about first. That’s why we have a dedicated section of our website for those beginning their investment journey. There are also some major pitfalls to avoid.

Taking the wrong level of risk

Getting the balance of risk and return right can take some consideration and depends on several 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.

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. Combining equities with high-quality bonds is diversification at its most basic, but historically it has been highly effective. There’s more on why diversification is important for investors here.

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.

Short term thinking and trying to time the market

Buying low and selling high is often the aim of market traders. However, investing is not the same as trading. 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.

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.

Yields are often based on past pay outs and therefore may not be a good indication of the coming year’s income. In some case they may not be relevant at all, as dividends can be cut, deferred or cancelled altogether.

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 2021/22 tax year ISA allowance is £20,000 and there is no extra cost involved with investing in our 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.

Find out more about Stocks & Shares ISAs in Erica’s video on our Youtube channel.

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.

Falling victim to a scam

Investors should always be suspicious of more obscure areas and investments that are unregulated. These could feature poor structures, high charges, bad governance and could even be scams. Be wary of any high, ‘guaranteed’ returns and always check if a business offering an investment is regulated using the FCA’s register available on their website.

Investment fraudsters will use a variety of techniques to try to take your money, including:

  • Make contact unexpectedly about an investment opportunity. This can be a cold call, email, or follow up call after you receive a promotional brochure out of the blue
  • Apply pressure on you to invest in a time-limited offer, offer you a bonus or discount if you invest before a set date, or say that the opportunity is only available for a short period of time
  • Downplay the risks to your money or use legal jargon to suggest the investment is very safe
  • Promise tempting returns that sound too good to be true, offering much better interest rates than those offered elsewhere
  • Call you repeatedly and stay on the phone a long time
  • Say that they are only making the offer available to you, or even ask you to not tell anyone else about the opportunity

If you’re contacted out of the blue about an investment opportunity, chances are it’s a high-risk investment or a scam. ​Scammers usually cold call but contact can also come by email, post, word of mouth or at a seminar or exhibition. If you get cold-called, the safest thing to do is to hang up. If you get unexpected offers by email or text, it’s best to simply ignore them.

As well as checking the FCA Register to see if the firm or individual you are dealing with, there is also an FCA Warning List of firms to avoid who are known to be operating without authorisation. If you deal with an unauthorised business you will have no protection from the Financial Ombudsman Service or Financial Services Compensation Scheme if something goes wrong.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Six investment pitfalls beginners must avoid

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