The schoolchild errors that make suckers of investors
From buying overpriced shares to swallowing hype about funds - costly mistakes to avoid
Sunday 29 April 2007
The key to a successful investment strategy lies not so much in picking winners - after all, predicting which sectors and shares are going to flourish is notoriously hard. Instead, it's more about avoiding costly errors. Here we look at some of the worst, and most common, mistakes made by individual investors.
Buying high, selling low
People tend to invest when they are confident about the outlook for shares, not when they are bearish.
While there is nothing wrong with that, the problem with small investors is that they tend to be bullish when markets are performing well, and bearish when they're doing badly - which means they buy shares when they're expensive and sell when they're cheap.
Instead of selling out when markets fall, investors should see lower share prices as an investment opportunity.
Take the market correction earlier this year. In just a few weeks between late February and early March, the FTSE 100 plummeted by around 400 points, losing 6 per cent of its value.
But anyone who sold in March would now be kicking themselves: share prices have stormed back and are now around their highest level for more than five years.
Trying to time the markets
There is an old adage stating that investors should "sell in May and go away, come back on St Leger Day". The significance of this date, 10 September, harks back to the time when the London markets wound down for the summer season. And while some statistics suggest there may still be some merit to this advice, staying invested over the longer term is a much safer strategy.
Figures from Fidelity show how costly it can be to try to time the markets. The fund manager found that someone who had invested £3,000 in a fund tracking the FTSE All Share index, and kept the money there for the 10 years to 2005, would have been sitting on an investment worth £6,418. But if that person had missed just the 10 best days on the index in this period, the figure would have been £4,262.
Following fashion, believing the hype
"Investors place too much emphasis on past performance - and particularly short-term performance," says Patrick Connolly of wealth manager JS&P Towry Law. "Because an asset class, or fund, has performed well, they believe it will continue to do so. The result is that they often jump on a particular bandwagon at the wrong time."
Mr Connolly says this tendency is to some extent the fault of the fund manage- ment industry: "Investors like to believe in the concept of the 'star' manager - a concept that is heavily promoted by investment houses and independent financial advisers who, guess what, want the public to buy products from them. Most 'stars' are heavily promoted after a short period of strong performance."
Mr Connolly also warns investors to beware of those who claim to know which investments will excel. "How many 'experts' predicted the stock market falls of 2000?" he asks. "Most were still busy plugging technology funds. The bottom line is that nobody can consistently call markets. It is dangerous even to try."
Failing to diversify
Whether it is because of an obsession with property or the temptation to stay close to home, most of us have too narrow a range of investments. If you want to spread your risk, you need to take a balanced approach.
That means putting money into different asset classes - property, equity, bonds and cash - as well as a range of investment funds.
A very common error among individual investors is to dedicate too much money to UK shares, which represent just 10 per cent of the total value of the world's stock markets.
Moreover, by restricting yourself to the UK, you could miss out on a number of important sectors where the UK has few leading firms, like computer software or biotechnology.
If you're usually adventurous, consider some "boring" assets, like cash or premium bonds. You will be glad of the security if your racier investments falter.
On the other hand, if you are usually a very cautious investor, you should think about allocating a small part of your portfolio to more adventurous funds.
Letting the tail wag the dog
Minimising your tax liability is an important part of financial planning, but it is easy to become too focused on keeping cash safe from the taxman.
You should not invest in complex, risky vehicles such as venture capital trusts or enterprise investment schemes just because they offer generous tax breaks; there must be a solid investment rationale for your purchases.
That is not to say you should forget about tax. Figures from Nationwide building society show around 60 per cent of UK adults do not use their individual savings account allowance, collectively gifting £500m to the taxman.
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