Many investors fail to make the most of their savings and investments. An analysis of private investor behaviour reveals some common mistakes, which, if avoided, could lead to better outcomes. The most common investment mistakes are:
1. Seeking the unknown
Trying to find the Holy Grail of ‘the best place to invest this year’, instead of focusing on long term returns relative to their own objectives. No-one knows what the best asset class, market, sector or individual shares, bonds or other investments will be in the short term. Any adviser who tells you they do should be avoided.
2. Investing after the event
Investing in whatever turned out to be the best asset class, market or sector last year. The problem with this approach is that by the time it is apparent which investments produce the best returns, the price of buying them has already gone up. The best investment of last year can quickly become the worst investment this year. Short term past performance is a poor guide to future returns.
3. Peer pressure
Listening to friends who tell them how much money they made on their best investment decisions and then following them into those investments. This leads to buying investments which may not be suitable for their own needs in terms of risk taking, liquidity of the investment, income yield or tax treatment.
4. Letting the tax tail wag the investment dog
For taxpayers, saving tax on investments can be important but avoiding tax on a profit can lead to poor investment decisions. For example, restricting realisation of gains to the tax free allowance of £11,700 will avoid capital gains tax, but if the investment then falls by more than the tax due, taking a bigger taxable profit would have been a better option. Similarly, investing in tax incentivised savings, such as VCTs (Venture Capital Trusts) or AIM (Alternate Investment Market) shares, should only be considered alongside the additional risk of loss entailed in these higher risk investments.
5. Being reactive
This may be in relation to events, which then lead to becoming too heavily invested in one sector or stock. Short term price adjustments rarely give rise to profits over the longer term. Trying to make a quick profit is difficult for private investors to achieve, as institutional investors are usually able to move more quickly, in short term positions.
6. Gearing your investments by borrowing to invest
While this may compound a gain it can also compound losses and leave the investor with a debt to pay off.
7. Comparing apples with pears
A frequent complaint is that cash based savings pay little interest compared to stock market dividends. When comparing investments always consider the margin of risk over the risk free return, compared to the degree of risk you can afford to take. Higher returns usually mean a higher risk of loss too and may require locking up your money for longer.
8. Managing currency risk
When investing abroad, there is danger in not separating the currency risk from the investment risk. Holders of foreign investments often fail to appreciate that they can sell the investment, without ditching the currency. Instead they hold on to investments, while waiting for the currency to adjust, only to see their investment gains evaporate. If you have overseas investments then hold a foreign currency cash account too, so that gains and dividends can be converted over time.
9. Not looking at the whole
Making decisions piecemeal about each investment owned rather than looking at all savings and investments on a coherent basis. Different investments often have different features such as permitted investments, risk of loss, income options, tax treatment etc. It is important to understand the overall asset allocation and liquidity in order to manage the risk taken and balance this with the need for access to cash. Making piecemeal decisions can lead to a series of investments that do not meet the investor’s needs
10. Not having a financial plan
A financial plan looks at financial goals first, then selects assets to achieve the income and capital yields required to meet the financial goals sought.
By investing in such a plan, then making your investment decisions fit around it, you may achieve better outcomes. It can be used as a framework to make future investment decisions as circumstances change. Ultimately good investment outcomes are about having the money you need to support your lifestyle and aspirations; this should be the focus, rather than short term considerations or seeking to outperform any given index or benchmark.
Director of Public Policy, LEBC
Please remember, no news or research item is a recommendation or advice to buy. LEBC Group Ltd is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment or product for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest. The Financial Conduct Authority does not regulate tax planning.Back to News & Views