Three investment mistakes to avoid
Even the most successful investors make mistakes sometimes, which may impact on returns. Here, we consider three common mistakes and how to avoid them.
What you’ll learn:Click to toggle accordion What you’ll learn:
Why it’s important to keep your emotions out of your investment decisions.
How trying to time the market could prove costly.
Why diversification is so important.
Even the world’s most successful investors admit they sometimes get it wrong.
Warren Buffett, for example, told his shareholders in 2008 that he’d spent $244 million on shares of two Irish banks that appeared cheap to him, only to see an 89% loss by the end of 2008.1
John Bogle, founder and former CEO of US investment firm The Vanguard Group, claims that one of his biggest mistakes was buying individual stocks for about a dozen years in the 50s and 60s, before he realised he “wasn’t getting anywhere”.2
Investing is far from an exact science, so it can be easy to make mistakes, particularly as many investment decisions are based on how investors hope or believe a company or fund will perform in future.
Here, we look at three common investing mistakes which could potentially trip you up and explain how to avoid them. Remember that whatever steps you take to try and prevent mistakes from happening, all investing involves risk, and there is the chance that you could get back less than you put in.
Letting your emotions dictate your investment decisions
When markets are volatile it’s understandable to feel nervous and want out. However, panic-selling can mean you crystallise paper losses and miss out on any potential recovery.
Dr Peter Brooks, Head of Behavioural Finance at Barclays, said: “You can help yourself avoid knee-jerk reactions by taking a long-term view. One way to do this might be to look at your portfolio performance less often. The aim is that by buying and holding your investments for a period of at least five years, but preferably longer, you don’t miss out on any of the best days by trying to time the market. Looking at the daily moves in your portfolio only makes this more difficult.”
There are other emotions which can also prompt you to make investment mistakes. For example, a long bull run may make investors over-confident, particularly if their portfolio has made significant gains.
If you are starting to feel more confident than you have previously, it’s important to keep in mind that past performance should never be seen as a guide to the future, and that market conditions can change overnight.
When you feel more confident you may take unnecessary risks, so remember to think about what your approach to risk was when you first started investing. Your portfolio may need rebalancing over time as your asset allocation can change because of the way your investments perform.
For example, say you began with 15% of your portfolio in shares. If they have done particularly well in recent years, you might find that they now account for a much greater proportion of your portfolio. You might therefore decide to reallocate some of your money to other assets to help spread risk.
Peter Brooks said: “Simply rebalancing back to the percentages you started with means selling those things which have done most well and buying those which have done less well. It reinforces a good sell high and buy lower behaviour while not encouraging market timing or pulling all money out of the portfolio.”
Trying to time the market
You’ve probably heard the stock market adage “buy low, sell high” but trying to time the market is easier said than done.
No-one knows exactly which way markets will move in future and jumping ship at the wrong time could mean you miss out on potential future returns.
If you’re worried about markets taking a sudden dip just after you’ve invested a lump sum, investing regularly can help smooth out market volatility. That’s because, when you drip-feed money in monthly, you buy more shares when prices are low and fewer when prices are high, effectively meaning you pay the average price over a fixed period.
As you’ve committed to investing regardless of market conditions, this can help remove some of the emotion from your investment decisions. Be aware though, that investing regularly won’t always produce the result you were hoping for and you can still end up losing money.
Failing to diversify
Focusing too much on one particular asset class, sector or geographical area could mean that if any of these fall in value, it may have a disproportionate effect on the value of your portfolio.
It’s therefore important to ensure your investments are properly diversified. This lessens the potential for losses, as it’s unlikely – although not impossible – that all the main asset classes will lose value at the same time.
Having exposure to a wide range of companies, industries and types of market from different regions around the world means that even if some of your investments underperform, hopefully some of your other holdings may rise in value, offsetting some or all of your losses.
The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.
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