It’s when markets rally as they have done this year that investors make one of the biggest mistakes of all.
By piling in at the top when the gains have already been made investors are flouting the Holy Grail of investing – buy low and sell high.
It’s just one of a string of common and costly errors that investors continue to make, however. Trying to time the market, pumping your cash into the latest “hot” fund or sector, taking your eye off the ball – these can all lead to a negative investment experience. Avoid these big investment mistakes and your portfolio will thank you.
DON’T TRY TO TIME THE MARKET
It’s always tempting, but even the best investors can’t get it right consistently. Those who bail out when share prices dip invariably miss out on sharp recovery – and the dividends that are paid along the way. Similarly, if you are thinking of piling into equities once markets rocket to an all-time high you may find there is a correction on the horizon.
Rather than second-guessing market movements, remember that it’s time in the market, not timing the market, which generates returns.
One way to reduce the risk of entering the market at the wrong time is to drip feed regular amounts in every month.
DON’T FOLLOW THE HERD
Too many people jump into shares when everybody else is buying, and sell when other investors head for the exit. This means that they repeatedly buy at the top of the market, when shares are expensive, and sell at the bottom, when prices have tumbled. It is a surefire formula for losing money.
Conversely, some investors seek out investment opportunities that go against the grain of what the market or most other investors are doing.
So-called contrarian investing works on the basis that the crowd is often wrong. Contrarians have a good sense of what a stock or market should be valued at and make a move when the herd is moving in the wrong direction.
With UK and US stock market indices hitting new highs in March, April and May, it is clear investors have been increasing exposure to these markets. Record highs are probably best viewed as a warning sign to do some further research before jumping in – or taking a more contrarian stance.
DON’T GET TOO HUNG UP ON PICKING STOCKS OR FUNDS
Asset allocation is the biggest determinant of portfolio returns: multiple research studies show that at least 90 per cent of a diversified portfolio’s returns are attributable to asset allocation. Despite this, most people mistakenly focus the vast majority of their efforts on the source of the remaining 10 per cent of returns – stock or fund selection.
Don’t make the mistake of spending most of your time on the decisions that will make the least difference to the overall performance of your portfolio. Don’t try to pick the next hot stock or top-performing fund when the experts who live and breathe this stuff consistently fail to deliver outperformance.
Instead, spend your time and resources determining the correct asset allocation for your goals and risk profile and you will be focusing on what really matters.
DON’T INVEST IN ANYTHING YOU DON’T UNDERSTAND
Before investing, make sure you fully understand what you are buying. This applies to both do-it-yourself investors and those investing through a financial adviser.
Unfortunately, it is not uncommon to hear stories of advisers who placed clients’ money in complex investment vehicles that are highly risky and not appropriate. This is not to say that you should steer clear of all complex products, but a competent adviser should be able to explain the proposed strategy.
Don’t be shy about pressing your adviser for an explanation, if one is not forthcoming, and make sure you fully understand the potential risks and rewards before taking the plunge.
If your adviser can’t explain a proposed investment to you in a fashion that you understand, simply don’t invest your money in that vehicle.
DON’T FOCUS EXCESSIVELY ON FEES OR TAXES
Nobody wants to pay too much or unnecessary tax, but don’t make the mistake of hanging onto an investment just because you don’t want to pay fees or taxes.
Investors can feel locked into a specific fund or product because the gain and subsequent tax liability when selling are perceived to be too large, even if the holding is no longer suitable for their circumstances.
The objective of investing is to maximise profits for an appropriate level of risk, and taxes and fees are just one component to that equation. Other factors, which might take priority over taxes and expenses, include risk control, asset allocation and expected reward.
Oversimplifying the decision by looking at just one factor can lead to an expensive mistake. Balance is the key.
DON’T TAKE YOUR EYE OFF THE BALL
While some investors obsess over their portfolio, tinkering and making frequent changes (which can also be damaging), others make the mistake of ignoring it completely.
Ideally, you want to review and rebalance your portfolio at least once a year to make sure your objectives are still being met, your risk tolerance is not being exceeded and that your holdings still deserve their place in your portfolio.
Just because a certain asset class has a specific risk and expected return associated with it when you set up your portfolio, doesn’t mean that this will continue to be the case as global markets and economies shift. If you have chosen a fund because you admire its manager, make sure you are aware if they move on. For example, Richard Buxton, one of the top performing and most popular UK fund managers, recently became the latest big name to jump on the fund manager merry-go-round when he quit Schroders for Old Mutual Global Investors.
Stockbroker Charles Stanley immediately announced that it was removing his Schroder UK Growth Trust from its “buy” list until a successor was announced.
• Simon Wigglesworth is a chartered financial planner at Edinburgh-based Cornerstone Asset Management