Three investment mistakes to avoid in 2025

Market optimism faded as 2024 drew to a close. In mid-December the US Dow Jones index recorded nine consecutive days of losses for the first time since 1978 – so much for a Santa rally!

Investors can look back on a fruitful year overall, though, especially in relation to the all-conquering US market. It was up by about a quarter, building on gains in 2023. And that’s despite a lot going on in the world: wars, political change, trade tensions, as well as inflation and interest rates staying higher than expected.

The main tailwind to markets was the US economy

A resilient US became the surprise of the year, and this in turn helped drive company earnings higher. Yet more impactful was simply that share prices grew more expensive in relation to earnings, reflecting greater optimism from investors about the future.

As we have become accustomed to, it was the big US technology names at the centre of all of this. Nvidia, the artificial intelligence (AI) chip maker was responsible for about one-fifth of the US market increase this year, and the wider “Magnificent Seven” provided more than 50% of the S&P 500's returns.

On top of the AI excitement there was also a positive reaction to Donald Trump’s victory in the US election with markets anticipating tax cuts that stand to boost corporate profits. Trump’s stated policies of higher government spending and tariffs on imports, as well as de-regulation and sourcing of cheap energy, favour US businesses exposed to areas such as infrastructure build, consumer spending and financial markets. US banks, for instance, have also had a remarkable year of share price returns, partly down to the Trump effect.

Investors see Trump as a potential catalyst for growth rather than instability

For now, that is, but it may not all be plain sailing. His policies, particularly those around tariffs and on immigration, have the potential to spark a fresh inflation surge. As well as being disruptive to companies around the world that export into the US, tariffs also have the capacity to disrupt some US companies and industries such is the complexity of modern supply chains.

US stock valuations give pause for thought

Against this complicated backdrop investors must work out whether the rich valuations of US companies are worth paying, especially among the top dog tech stocks that have led the way for the past decade. Most investors will have a decent slug of exposure to them, if only through holdings in US or global trackers, so it is worth taking time to consider whether you still have the right balance. Gains on Wall Street were not matched elsewhere in the world over 2024, and that could have led to investors having a lopsided portfolio that relies a lot on a handful of businesses.

While it is often worth paying for quality, the US has never been a bigger part of the global market and rarely this expensive. If the ‘winner takes all’ corporate Darwinism continues and US companies continue to dominate, investors will regret paring back exposure too much. Yet risks are building around the uncertain geopolitical landscape, the scope for trade disruption, and the trajectory of inflation and bond yields. A further inflationary impulse combined with concerns about the sustainability of government debt would be a headwind to both shares and bonds.

To help guide your thinking about the year ahead here are three important mistakes to avoid.

Don’t take too much, or too little, risk

Investing is always a balance. Taking risk is necessary to generate an acceptable return ahead of inflation, but take too much at the wrong moment and you can end up derailing your plans. There are plenty of risks out there. Events may come along to test or disrupt this year with markets likely impacted by news on inflation, the outcome of Trump’s policies in the US, and how economic growth fares. Yet there are also great long-term opportunities and a well-thought out and diverse portfolio should stand investors in good stead.

When considering the inevitable ups and downs of investing, it can be easy to equate it with gambling, but that would be a mistake. In gambling there is, realistically, an expectation of a negative outcome. You might win some bets initially, but the more you do it over time the more likely you are to lose money. Investing is the reverse. It’s perfectly possible to lose money, and many people do, especially over short time frames or by focusing too much on a single stock or area, but over the longer term there is expectation of a positive outcome. That means longer you keep doing it the more likely it is that you will make money.

The problem is events, especially unexpected or ‘Black Swan’ occurrences, often cause investors to panic and sell out at just the wrong moment. Instead, it’s generally best to keep going, stay invested and adjust portfolios according to where a good balance of risk and reward lies. That could mean tilting more towards more risky areas at times but being more defensive at others, but ultimately having a portfolio that takes sufficient risk to secure strong long term returns but is sufficiently diversified so not to be reliant on a particular scenario playing out, or a small number of stocks or areas doing well.

Don’t reach blindly for yield

Investors are naturally attracted to investments producing a high yield, the yardstick by which the income an investment produces is measured. Generally, this is the amount it has paid over the past year divided by its price, expressed as a percentage. Although some yield calculations, notably for bonds, are forward looking and include the capital return or loss built in too.

Bear in mind that a high yield can also be a warning sign. There is likely to be a very good reason why it looks so good. For bonds, higher yield means higher risk and there is more chance of default and capital loss. For shares it may mean there is a strong chance that dividends, the pay outs to shareholders, are going to fall rather than rise.

This is especially relevant at present as the rising interest rates of the past couple of years are creating corporate winners and losers. Those with low levels of borrowing, or even net cash on their books, are in a strong position, but for those renewing lots of debt at current levels there may be trouble ahead if they find it increasingly difficult to service or repay debts.

It is therefore worth considering a selective approach in the riskier high-yield end of the bond market where defaults are more likely to arise. Meanwhile, for those focusing on dividend-paying shares it suggests a focus on quality and strength is important, as well as a need to harness enduring structural growth themes. As always, diversification by sector, geography and type of asset is wise to help reduce risk and ensure you are not overly reliant on one area or on certain circumstances.

Don’t be ‘absolutely’ wrong (it's OK to be a bit wrong)

Football managers frequently say they learn more about their team from defeats than from victories. It’s a similar story for investing. Mistakes are inevitable, and they can be helpful as they can reveal flaws in your approach, so it’s good to analyse them and question how they might have been avoided.

Never forget that a result by itself tells you nothing about how it was achieved. A good gain might have been attained through careful, well-informed investment or it could have been a wild gamble. To expand the football analogy, a team might be fortunate enough to win the match with a speculative shot from the halfway line, but that’s not going to help with tactics against the next opponent.

Picking winning stocks is very difficult because, at the risk of stating the obvious, the future is uncertain. Uncertainty about how companies might compete, expand and adapt; industry changes, the effect of regulations; demographic trends; economic challenges – the list is endless. What you see each day with share prices erratically moving up and down is investors trying to grapple with these uncertainties and price them in. The world is challenging for companies to navigate and that is especially the case today as the pace of technological change and disruption is so rapid.

How can investors stand a better chance of winning? Falling back on another sporting analogy, rather like a successful tennis player it’s more about making as few mistakes as possible than it is about attempting spectacular, higher-risk shots that impress the crowd. Avoiding the problem stocks and overvalued areas that result in permanent capital loss is more important than pinpointing all the winners – it’s far better to be about right through diversification and risk control than it is to be absolutely wrong.