When it comes to investing, it is quite easy to get advice from people – friends, family, journalists and of course financial advisers. They will be only too happy to tell you what to do! However, this article is a little different in that it tells you what not to do.
Here then are a few of the ‘don’ts’ to bear in mind when investing. Many sophisticated investors will already appreciate most of these but a salutary reminder in times of uncertainty is no bad thing.
To start off, don’t invest for the short term. Investing is a long-term game, so consider a three to five year time horizon as an absolute minimum. Don’t feel that you have to respond to every rise and fall in the market and don’t feel that you need to buy everything at once. Drip-feeding money into the markets or buying on the dips can be a good strategy for success.
Secondly, don’t keep changing strategy. Decide at the outset your financial objectives, take into account your circumstances, your risk tolerance and the level of volatility you are prepared to accept, then set a financial strategy and broadly stick with it.
Thirdly, don’t follow the herd. In other words, don’t be impulsive and jump on the latest investment bandwagon. It is natural to want to invest in exciting 'hot stocks' or the latest star fund manager. However, it is often the case that by the time you hear about this latest hot investment, the bandwagon has already passed and you could be buying near the top of the market. Recent history has shown the problems for some with this approach.
The world-renowned Warren Buffett has made billions as a contrarian, investing against the herd. As he once said – ‘most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well’. Which is all well and good, but in practice, investing against the herd is easier said than done.
A similar mistake is to choose the best performing share or fund without taking into account how risky it is. A fund may well have outperformed simply because its manager is taking on a lot of risk - a strategy that may pay off well in a rising market, but could backfire if markets fall. You should look at the volatility of an investment as well as its potential returns. A high risk investment may suit you but don’t take unnecessary risks.
Following on from this, don’t panic and sell your investments that are falling in value. This is certainly not the best time to sell. The aim should always be to buy low and sell high. Time is an investor's biggest friend, as it allows the benefits of compound returns to take effect. Buy good investments and give them time to work.
Despite all the above, don’t be afraid of risk. Don’t become so afraid of the volatility of investments that you only invest in cash. Cash does not tend to be a good long term solution and is not risk-free, as inflation eats into its value.
At the same time, don’t forget to hold some cash. Not only does cash reduce a portfolio's volatility, it also means that you are in a position to take advantage of new opportunities quickly, without having to sell something else when it might not be the right time to do so. Almost any investment portfolio should contain an element of cash.
Which leads nicely onto the next point; don't put all your eggs in one basket. In other words, don’t be too focused in your investment approach. Even the most aggressive investor needs to have a spread and balance of different holdings.
An undiversified portfolio almost by definition will only perform well some of the time. Diversification mitigates risk, because different sectors or assets perform well at different times. Remember the banking crisis of 2008 and the technology crash of 2000? Investors who were over-exposed to these areas suffered heavy losses.
A little caveat though; don’t be too diversified. If you diversify too much, your portfolio will tend towards the mean and simply track the market - what is sometimes called 'diworsification'.
Another salutary reminder is, don’t focus on the past - look to the future. Buying one of last year's top performers is the easy option – and it’s why so many people do it. However, history has shown that last year's best performing investments or market sectors rarely repeat the trick.
People often ignore the ubiquitous regulatory phrase – "past performance is not a guide to future returns.” Yet it is put there for a reason – it is essentially true. Of course, past performance can help when assessing an investment's potential, but it only forms part of the equation. You need to understand why an investment has performed well or badly and there could be various reasons.
Next, don’t give yourself sleepless nights. If a particular investment opportunity sounds exciting but worries you, don’t do it. All equities, bonds and funds rise and fall from one day to the next. Some of the most volatile investments have great profit potential, but obviously the risk of loss with them is always greater, particularly in the short term. Unfortunately, there is no such thing as a risk-free investment. Even cash itself is not risk-free and loses value in real terms, as inflation takes its toll. So you need to be clear on your risk tolerance before investing.
Obviously too, don’t listen to the 'man in the pub' - or to dinner party chat - where exciting so-called investment opportunities can sometimes be aired. Firstly, they may not be what they seem and secondly any investment that might be of interest to someone else is not guaranteed to suit you. Your circumstances and financial objectives could well be completely different.
The above are a few pointers to bear in mind when you are looking to invest. One final one – if you need help with your investment portfolio, don’t forget to seek independent financial advice. An initial meeting with Kellands is free and without obligation, so don’t forget to get in touch.