Article

Six investment pitfalls beginners should avoid

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

| 9 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 interest paid typically isn’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.

    Having all your eggs in one basket might make you a fortune, but it might lose you one too.

    Everyone is different, but if you are more cautious or have less time to invest, you’ll probably want to have more ‘balancing’ assets to temper stock market volatility, notably bonds representing loans to governments or companies. These pay interest to the holder and tend to provide a lower return in the long term compared to shares but can still do better than cash. Although, it is fair to point out that recently with inflation concerns rising, they have been under pressure too. At least going forward there should be more benefit from holding both.

    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.

    Buying last year’s ‘winners’

    Investors are often attracted to top-performing funds or shares. However, buying in without having any idea of why, or whether it offers value relative to similar assets, can be dangerous. In particular, don’t buy a fund just because it is top of its sector over a short time period. It is often surprising how quickly funds flip from the bottom to the top and vice versa. Consider longer-term performance and, in particular, returns over discrete years to give you an idea of how the fund has behaved over time.

    Concentrating too much on past performance can also create a portfolio that has the ‘illusion’ of diversification where, actually, you have various flavours of essentially a similar thing rather than a mixture of components with differing characteristics. It is important to understand which assets protect you if things take a turn for the worse or you are wrong, and if you don’t have any of these then you should consider them if you are looking to limit volatility.

    Short-term thinking and trying to time the market

      Buying low and selling high is often the aim of market traders. However, investing is different. 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. Sitting tight is easier said than done when markets are falling, but these testing periods are an inevitable and normal part of investing. They happen from time to time, but it’s hard to predict when and why. Yet in the long term, they can also present good opportunities to acquire assets as others despondently sell.

      Being attracted to the highest yielding investments

        Some investors are particularly attracted to investments producing a high level of income. Yet 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, a higher yield means higher risk – there is more chance of default and capital loss.

        Yields are often based on past payouts and therefore may not be a good indication of the coming year’s income. In some cases, they may not be accurate at all, especially for shares, as dividends can be cut, deferred or cancelled altogether. Over the long term, it is often better to opt for a company share with a lower payout that has good potential to grow it rather than the highest immediate income.

        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 2022/23 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 YouTube.

        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. The tax treatment of pensions depends on individual circumstances and is subject to change in 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 for 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 should avoid

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