Any savvy investor knows the basic principle of investment: buy low, sell high. However, investors often ignore this rule, as they get swept up in prevailing market sentiment.
When markets have stormed ahead, sentiment is positive and people are more likely to invest as they don't want to miss out on further gains. Conversely, when markets have performed poorly, sentiment is negative and people are more likely to head for the exit due to fear of clocking up further losses.
Patrick Connolly, at AWD Chase de Vere, the independent financial adviser, says: "People make too many irrational investment decisions, which are based on either greed or fear. The result is that many people invest at the top of the market and withdraw their money at the bottom, having a thoroughly miserable experience of investing along the way."
Waiting for markets to turn the corner could mean you'll miss the boat. Britain has experienced four recessions since the Second World War, and on each occasion markets rallied strongly the year after: up 142 per cent in 1975, 29 per cent in 1982, 20.7 per cent in 1991 and 45.9 per cent in 2009.
"This highlights the extent to which equity markets look ahead of the economy and bad news is factored in early on," says Adrian Lowcock at broker Bestinvest. "In trying to avoid losses in the short-term, investors may well miss out on the significant rebound of the market and end up being behind the curve for any recovery."
Here, we ask investment experts to share the 10 big investment mistakes. Avoid these, and your portfolio will thank you ...
1. BUYING HIGH, SELLING LOW
Industry figures show that investors have a habit of pouring money into stock markets when they're flying high and taking it out when they've suffered a correction.
The FTSE 100 peaked at 6,930 on 30 December 1999 and net retail investment sales remained positive until 2004-05. In fact, in 2000-01 – the peak of the market – investors pumped £5.86bn into retail funds, according to the Investment Management Association.
The index bottomed at 3,287 on 12 March 2003, but there were still five years of negative sales following this. In 2004-05, investors took a net £1.19bn off the table.
The picture was similar during the most recent stock market crash. On 3 March 2009, the UK's blue-chip index fell to 3,512. During 2008-09 – the market low – investors sold £305m of investment fund holdings.
Those who gave into their fear lost out on a sterling rally. The FTSE 100 stands just shy of 6,000 today.
2. TRYING TO TIME MARKETS
Investors' habit of mistiming markets costs them more than 1 percentage point a year in returns, according to an academic paper from Cass Business School. The research, compiled using performance and sales data figures from 1992 to 2009 and commissioned by Barclays Wealth, shows that market timing decisions by retail investors in mutual funds has reduced their returns by an average of 20 percentage points over an 18-year period.
Andrew Clare, professor of asset management at Cass, says: "Over the 18 years covered by our study, a buy and hold strategy would have turned an initial investment of £100 into £311, but because of the poor market timing abilities of the average UK retail investor, the investment would only be worth £255."
3. FOLLOWING THE HERD
The most obvious example of investors following the herd is the technology boom of the late 1990s.
"At that time, sensible investment strategies went out of the window and even pensioners relying on their investments for income were selling corporate bond funds and moving into technology, not wanting to miss out on the easy money," says Connolly. "This trait has been repeated many times: property became very popular in 2006 following a return of 26 per cent, but soon there was a queue at the exit door after the sector lost 15 per cent in 2007 and 30 per cent in 2008."
In more recent times, investors have piled into gold and other commodities. Remember: if an investment hits a record high, view it as a warning sign, not a reason to buy.
4. HOLDING OFF
Despite the annual last-minute rush for investors to use their individual savings account (ISA) allowance before the end of each tax year, you'd be far better off being an early bird. Investors who use their allowance earlier in the tax year, rather than holding off to the last minute, could be £6,361 better off over the longer term, according to Fidelity International.
This amount was calculated using the growth in the FTSE All-Share index over a 15-year period. However, investors choosing a more aggressive, actively managed fund, such as Fidelity's Special Situations, could have benefited to the tune of an extra £22,039.
Rob Fisher, head of personal investments at Fidelity International, says: "Investing earlier rather than later in the tax year simply gives your money more time to grow in the market over the long run. Put another way, more of your money is sheltered from the taxman for longer."
5. IGNORING COSTS
Investors should ignore costs at their peril. Buying investments through a fund supermarket can save up to 5.5 per cent in initial charges. That equates to £587.40 for this year's £10,680 ISA subscription. Over 10 years, you could boost your investment returns by £1,051, assuming investment growth of 6 per cent, says Hargreaves Lansdown.
6. PAYING TOO MUCH TAX
Not holding investments in an ISA is a little like walking past a tax free-bee. Investments held outside these tax-privileged wrappers are subject to tax on income and gains.
"Some banks, asset managers and stockbrokers would have you believe that an ISA is more expensive than simply holding a share or unit trust – and they would be right if you bought your ISA through a firm that charges you more for ISA investments than normal investments," says Danny Cox at Hargreaves.
"Most fund supermarkets charge the same for ISAs as for taxable investments, meaning the tax benefits are free."
Non- and basic-rate taxpayers should shelter their investments as much as higher-rate payers. Non-taxpayers are subject to capital gains tax at 18 per cent on the growth of their investments, after the capital gains tax allowance of £10,600, if not held in ISAs.
Basic-rate taxpayers save 20 per cent income tax on cash and fixed interest investments in ISAs. Furthermore, after age 65, those with taxable income between £24,000 and £28,930 start to lose their age-related allowance at the rate of £1 for every £2 of taxable income – an effective tax rate of 30 per cent, says Cox. However ISA income is free from further tax and doesn't count towards this means-tested benefit.
7. HAVING A HOME BIAS
Most investors have too high a proportion of their assets invested in their own country and too little in rapidly growing overseas markets. British investors have 3.5 per cent of their assets in emerging markets, 10 percentage points less than their weighting in the MSCI Global Equity index, says Tom Stevenson, investment director at Fidelity International. By contrast, they have 49.8 per cent in UK assets – about 40 percentage points more than the "correct" weighting.
8. NOT REINVESTING DIVIDENDS
The reinvestment of dividends is one of the most important determinants of total returns over time. Figures from Barclays Capital's Equity Gilt Study 2011 show that £100 invested in the UK stock market in 1899 would have grown to be worth £12,665 in capital terms, but to £1.7m with the benefit of reinvested dividends. "This is the power of compound interest at work," says Stevenson.
9. CONFUSING TOLERANCE WITH CAPACITY
An investor's risk tolerance is a measure of their temperamental willingness to take on risk, while their risk capacity is their ability to recover losses if they incur them.
Stevenson told The Independent: "A 35-year-old has a higher risk capacity than a 55-year-old because if the market falls 20 per cent they would not need to increase their annual return by very much to get back on track.
"For the older investor, a fall of this magnitude close to retirement may be difficult to claw back. Unrelated to their risk capacity, either investor may or may not have a high risk tolerance."
If you're young – and have plenty of time to recover from adverse market moves – you should focus your portfolio on the assets with the best long-term performance track record: equities. Closer to retirement, when you can't afford to incur heavy losses, hedge your bets by spreading your money between different asset classes.
10. LOSING YOUR BALANCE
Maintaining the balance of lower- and higher-risk assets is important, so that the actual risk you're taking doesn't get out of kilter with your tolerance to risk. Rebalancing brings a dual benefit: it reduces volatility and is likely to produce a better return.
A balanced portfolio of funds chosen 10 years ago would have generated 15 per cent more profit if it was rebalanced to the original proportions each year when compared to a portfolio left untouched, says Skandia. Rebalancing controlled the volatility of the portfolio, too, with the rebalanced investment experiencing volatility of 11.6 per cent – the lowest of four scenarios examined.
Some fund supermarket platforms offer automatic rebalancing. Investors can do it manually by switching funds or asking their financial adviser to do so.