Winning and losing is part and parcel of investing. Nobody can win every time, and nobody can make perfect investment decisions consistently. However, there are many mistakes that can and should be avoided – simply through being aware of them.
In this article, our financial advisers at Cedar House have compiled five of some of the most common investment mistakes they have seen over their many years of experience.
#1 Not having a clear investment plan
A lot of people approach investing in the same way as gambling – looking for a “quick win”. This is usually a recipe for disaster, as proper investing involves taking a longer-term view and having a clear plan to minimise your losses.
Essentially, successful investing requires a clear plan. For instance, rather than throwing lots of money at a “hot stock” which everyone is currently excited about (hoping for a big, quick return), look at how you could spread your money out across lots of investments.
This “diversification” helps to mitigate your risk exposure. After all, if you invest all of your money in one company and it fails – you stand to lose it all. If you spread it out across, say, 100 companies and only a handful fail, then you still could gain from the successful ones.
Have a clear set of goals in mind, and commit to the longer-term. For instance, perhaps you want to start investing over the next 20 years to build up your retirement savings. In that time, you expect your investments to go up and down, but also gradually deliver steady growth.
#2 Using money you cannot afford to lose
Some investments are “riskier” than others. For instance, investing in an exciting new tech startup could deliver a huge return for you if the company takes off down the line. However, there is also a good chance that the startup might fail, and your investment is lost.
An investment like this is usually seen as riskier than, say, investing in UK government bonds. Since the government is widely perceived to be reliable when it comes to paying back these debts, the investment is seen as relatively safe. The trade-off is that the potential return on your investment is also lower.
There is nothing wrong with either kind of investment. High-risk and lower-risk investments have their place within each person’s specific portfolio, and the balance will vary depending on your goals, resources and risk tolerance.
With that said, a good general principle is to not commit money you cannot afford to lose towards a higher-risk investment. For example, putting all of your emergency savings into an EIS-qualified tech startup might seem like a good idea (think of the thousands you could make!). However, if your investment fails you will likely then face significant financial pressures.
#3 Investing without understanding
One of the worst things you can do is invest in something you do not understand.
Sometimes, people do not ask questions to a financial services company about a particular product or investment, for fear of looking naive or being taken advantage of.
However, as Sir Francis Bacon once said: “knowledge is power.” You are more likely to make wise investment choices if you understand how an investment works and affects you.
For instance, do you know what a mutual fund is? Do you know what capital gains tax is? If not, there is no shame in asking a financial adviser to explain these things to you. There are also plenty of useful, free resources online which you can use to learn on your own.
Investing in something without knowing its essential features and mechanics can often leave you regretting it later. Perhaps the time eventually comes when you want to withdraw you money, for instance, but there are exit penalties which you didn’t know about or understand. Protect yourself through education.
#4 Timing the market
The story of Isaac Newton is famous in financial adviser circles for a good reason – it illustrates the danger of trying to time the markets for a higher investment return.
Newton was an ingenious scientist but not the smartest investor. In 1720, he owned shares in the South Sea Company – which at the time was the most “talked about” stock in England.
Feeling uneasy that the stock would fall, he sold all of his shares for a 100% profit (about £7,000). However, the stock continued to climb and he watched his friends (who had held onto their stocks) continue to profit.
Wanting back in on the action, Newton bought stocks again in the company a few months later – this time at a higher price. As luck would have it, the stock then plummeted and Newton lost £20,000 – the equivalent of about £3m today.
Really, this story illustrates at least two lessons. First, do not try and time the market. Secondly, beware of getting swept up in the crowd. Just because everyone else is pouncing on a hot stock which looks like it is about to take off, does not mean you should too.
#5 Relying solely on past returns
It is important to look at a fund’s past performance when selecting an investment. However, focusing solely on this can actually obscure the picture.
For instance, it is also useful to look at how well a fund performed during market turbulence. A good example is the 2008 financial crash. Lots of funds lost their clients’ money during that year, sometimes 16% or even more. However, some funds certainly lost more than others.
This better “cushioning” might be partly due to the fund’s specific mix of investments, but it could also be an indication that the fund has strong risk controls in place to mitigate the hard times.
In other words, do not just look for funds or investments that have provided strong returns in the past. Look also for a fund which did not suffer as badly as comparable funds during hard times, and consider whether these might offer stronger investments safeguards.