Everybody hopes to generate a solid return on their money when they invest. But many investors end up losing money, whether this is due to the type of investment they choose or the decisions they make later.
In many cases, this loss occurs due to poor investment decisions which could have been avoided. On the other hand, lots of people miss out on promising investment returns due to excessive fear of loss, leading them to be overly-cautious with their portfolio.
For instance, committing most of your money to cash (rather than, say, stocks) is potentially a way to lose money over the medium to long term. While there have been brief moments when cash interest exceeded the rate of inflation, these are rare anomalies and not sustainable for the long-term. Over a period of 5 years or more, it is highly unlikely that even a market-leading savings account will keep up with the rising cost of living.
With inflation currently sitting at 4.7% and a cut to interest rates strongly predicted within the next couple of years, you would likely lose buying power by focusing on cash rather than investing.
So, avoiding investing is hardly a wise strategy. But how can you avoid many of the common mistakes made by investors every day?
In this article, we’re going to share 4 common investment mistakes to avoid. Please note that this content is for information purposes only, and does not constitute financial or investment advice. For regulated, impartial advice regarding your wealth and financial affairs, please consult with an independent financial adviser.
Mistake #1: Bargain traps
Most of us love to feel like we’ve found a bargain. We often do this when it comes to retail shopping, and this can seep into our investing decisions.
With investing, the idea is that you buy shares in a company or asset which is undervalued, then watch it turn things around to net a fantastic return.
Many people regarded Bitcoin in this light, for instance. Starting at only around a few cents per Bitcoin in 2009, the price soared to over $68,000 by December 2021. Buying at the bottom of the market would certainly have yielded strong returns if investors cashed out at the right time. At the time of writing, the price is around $43,000, meaning that anyone who joined the bandwagon later would most probably have lost money.
The difficulty with basing an investment strategy on “bargain hunting” is that it is difficult, if not impossible, to predict which stocks, funds or assets are indeed undervalued and will later go on to perform spectacularly well. By the time most investors have heard of these investments, the price has already risen. And this is before taking into account the multitude of scams or gimmicky products which are highly touted, but essentially worthless.
Mistake #2: Risking money you cannot afford to lose
This mistake commonly occurs hand-in-hand with the first, where people will sometimes even go into debt to jump on a cheap deal which looks “guaranteed” to provide a return.
Clearly this is a potential huge mistake and should be avoided. Getting into debt to buy an investment (which will never be a ‘sure thing’) can have devastating consequences from a financial point of view, as well as impacting your relationships and mental wellbeing. Not only have you lost money in this case, but you are still stuck with the original debt.
However, this principle does reach further than simply avoiding going into debt to make investments. You should also be wary of committing too much money to an investment portfolio, whilst neglecting your other financial responsibilities.
Does it make sense, for instance, to invest heavily in a portfolio without keeping aside an emergency fund to cover any unexpected costs or bills? What would happen if you were suddenly out of work and couldn’t access your investments? A sensible investment plan is all about balancing priorities.
Mistake #3: Short-term mentality
Investing in the hope of strong returns in a short space of time is rarely a good idea. All investments fluctuate on a daily basis and may go up or down at any point. Yet most investors tend to agree that investing is most effective when you take a long-term view.
The stock market is a case in point. Typically, an index such as the FTSE 100 will rise and fall even within the space of a year (or a week, or even a day). Over ten or twenty years, however, indices such as these tend to see a rise in value.
So, if someone invests in an index like this and then sells within 12 months, they are quite likely to lose money. If they hold it over the long term, however, they can reasonably expect a return.
The benefits are increased by investing in a diverse portfolio across different asset classes, world regions, and sectors. This can help to smooth out some of the volatility as you don’t have too much concentrated in one area.
Mistake #4: Little/no due diligence
Anyone who has watched Dragon’s Den will be familiar with the concept of doing due diligence on individual companies, to “stress test” their viability and see how strong their fundamentals are. The stronger the company, the reasoning goes, the more likely it is to provide an investor with a return on their money.
The same holds for other assets, however, as well as funds. A fund might look terrific and even have a strong track record of past performance. However, if it is constructed poorly and contains inherent weaknesses which could leave investors exposed, then you might want to consider putting your money elsewhere.
The Woodford Equity Income fund is a good example of this. It was suspended in June 2019 and became the subject of an FCA investigation. The value of the fund has dropped from £10 billion at its peak to around £36 million as of September 2023. Many investors are still awaiting compensation.
The fund began to collapse after investors started pulling out due to poor investment performance, leading Woodford to sell off listed shares – which left the fund excessively tied up in unlisted, unquoted assets.
The fate of the Woodford fund offers a lesson, not only around looking under the bonnet when a fund looks like it is performing too well, but also in putting too much faith in a ‘star’ fund manager.
The principles of investing are simple and stand the test of time – invest for the long-term, diversify your assets, and avoid making decisions driven by fear or greed. Stick to the plan, and you will soon see the benefits.
The content in this article was correct on 05/02/2024.
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