There are many traps that investors can unwittingly fall into. Here are some of the most common mistakes, outlined by RPlan.
This article first appeared on Your Money.
Sin no 1. Following fads
Fashions come and go in investing, often to the detriment of individual investors. A good example of an investment fad was the 'dot-com bubble' – which was followed by an enormous downturn.
Many of the 'dot-coms' became insolvent, and those who had followed the trend lost money. Instead of trying to guess the next 'big thing', create a well-balanced portfolio which will bring you decent returns, at a level of risk level that you are comfortable with.
Sin no 2. Thinking like a trader
Investing in ‘collectives’ such as funds or Exchange Traded Funds (ETFs) is very different to investing directly in stocks & shares. Collectives aim to provide long-term returns rather than short-term profits, and don’t tend to be bought and sold as often as shares are.
Timing the market involves a great deal of research, knowledge and understanding as well as good technological facilities. Even Warren Buffet, one of the most successful investors of all time, admitted to occasionally mistiming his investments, resulting in multi-billion dollar losses. It's usually better to think of investments as a something for the longer term.
Sin no 3. Losing control over your fees
Most investments come with a charge; it's important to keep your charges at a reasonable level, because they reduce the gains you make on your investments - the more you pay, the less you effectively gain.
In some cases, higher charges can be worthwhile, where you are getting good service or good performance; the key is understanding what they are, so that you can make sure that you're getting good value for money.
Here are some of the charges to look out for:
- Investment management fee - 0.75% p.a. (avg.), paid to the fund manager
- Provider/adviser fee - 0.5% p.a. (avg.) - commission paid to your broker/adviser
- Platform/administration fee - 0.25% p.a. (avg.) - paid to the platform for administering/maintaining your holdings
- Fund expenses - 0.25% p.a. (avg.) - fund manager audit fees, trading costs, etc.
It is always good to look for the total expense ratio (TER) or the ongoing charges figure (OCF), which sums up all fees mentioned, rather than the annual management charge (AMC) which does not cover some of the additional expenses of a fund.
In some cases, a fund manager may charge a performance fee if the fund is performing well, but it is important to check what benchmark they use to determine this. Finally, providers may have dealing costs that can add up, or hidden charges such as exit or account closure fees.
Sin no 4. 'Set and forget'
Many investors forget that looking after a portfolio is an ongoing process. Make sure to continue monitoring your investments after buying, as their value and proportion in your portfolio will change over time and as a result could no longer meet your goals.
You could also consider periodical rebalancing as a part of your regular portfolio maintenance.
A recent Vanguard study, over a 83-year period, indicates that rebalancing when current asset allocation deviates more than 5% from the original target (usually between 6-12 months), has proven to be a successful strategy.
Sin no 5. Buying individual funds instead of building a portfolio
Instead of focusing on individual funds, it's good to look at the big picture and see all your investments as key elements of your portfolio. These parts should then work together to provide returns that you aim for at your desired risk level. Balancing the risk level of your portfolio is also improved when looking at the whole instead of individual funds.
Sin no 6. Not diversifying
As a rule of thumb, investing in any single asset is more risky than spreading your assets across different investments. If something goes wrong, your entire portfolio is at risk. Diversification is a good way of reducing investment risk, and can be used for building a portfolio of any size.
Investors diversify their portfolios by allocating portions of their money in a variety of assets, sectors, markets and geographical regions. The allocation would normally depend on the investor's personal circumstance, such as time-span, risk tolerance, etc.
Sin no 7. Not investing
'Not investing' may seem a little bit obvious, but many people keep postponing their first investment for years or sometimes even forever. One of the key benefits of investing is the power of 'compounding', which helps investments grow considerably over a longer period of time.
By starting with smaller sums sooner rather than later, you will benefit from compounding for a much longer period. It simply means that in total, you need less money to reach the same goal in the distant future (such as retirement) if you start now than if you start in ten years.
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