Five mistakes to avoid when investing

The Covid-19 pandemic has rattled the lives of almost everyone. People have lost jobs, been socially hamstrung and had to change plans on the fly to respond to what has been a year of crippling uncertainty. A side effect of this chaos, though, has been people reassessing what is important in life and looking to wrest control where they can. 

Against this backdrop, one thing we’ve noticed is an uptick in public interest in investing. Whether you’ve had your finances affected by Covid-19 or not, personal finance has been put into sharper focus and more people are making an active effort to secure themselves financially over the long term. 

So, for anyone looking to get started with investing and build a better financial future for themselves, here are five key mistakes you’ll want to avoid. 

Failing to stick to your time horizon

When people put together investment plans, they do so with a time horizon in mind. The number of years you plan to invest for has a significant impact on everything from the assets you’ll want to put money towards, to the overall risk profile of the portfolio. For example, those investing for the long term can generally take on more risk than those looking to preserve wealth over the short term. 

One common mistake investors make is pulling their money out when times get tough or doing a U-turn on what they were putting money away for in the first instance. Situations can change and financial priorities can shift, but it’s important to broadly stick to the time horizon you outlined when putting together your grand plans. If you’ve invested for the next 25 years, it makes little sense to withdraw that cash in five years’ time from an investment not optimised to be accessed that early. 

For a fuller explanation of how sticking to the plan can benefit investors, we looked at the temptation to disinvest during uncertainty (caused by issues like the pandemic). The cost of cutting the time horizon for an investment short can be severe, while in most cases time can be an investor’s greatest asset.  

Not diversifying your investments

Another common mistake investors make is to focus too heavily on certain regions, businesses or asset types. Home country bias, confidence in a business to succeed or a preference for bonds are all understandable reasons to want to invest a certain way. 

For decades, though, the concept of ‘diversification’ has been growing in the world of investments, arguably becoming the most important feature in any portfolio build for long term growth at a reduced level of risk. The general principle of diversification is that, with enough of a spread across industries, geographies and asset types, any dips in one area can be made up in others. Diversification makes for the kind of long term, robust investing that most people are comfortable with. 

There are downsides to diversification – it takes time and can be expensive. This is simply due to the number of assets you’ll have to hold to have an effective diversification strategy. Fortunately, this is where services like Moneyfarm can be help: we offer low-fee, fully managed portfolios with diversity built-in. Check out our options and find a portfolio that suits you by clicking the button below. 

Trying to time the market

Whenever crises take place, we see a surge in the number of people practising ‘go it alone’ investing. The huge swings in the market that often come with crises tend to make headlines. For a lot of people, it means temporarily losing money or seeing the value of investments dip – for a much smaller contingent, it represents an opportunity to invest at a discount rate and ride the wave upward. Attempting to ‘time the market’ in this way is dangerous and, ultimately, not that effective when a long-term perspective is taken. 

The problem with this approach is that, on top of needing a wealth of technical knowledge and a crystal ball, you also need to be lucky, repeatedly. There is nothing stopping a lucky investor backing the right horses at the right times and making themselves a lot of money in the process. Equally, there is nothing stopping one bad bet ruining all their progress. 

We should note that there is a difference between timing the market and investing when you feel that the market is due a resurgence. Most people that invested during the worst economic moments of the pandemic will have already seen their money grow. If you feel that now is a good time to invest, go for it, but don’t make it an intrinsic part of your strategy. 

The best time to start investing is, almost always, as soon as possible. As unexciting as it might sound, a slow and steady approach gives investors the best chance of making positive returns over the long term. If you’re not investing to make a quick buck, it’s a good idea to avoid trying to time the market. 

Sticking with an underperforming wealth manager

When you invest for the long term, people (including us!) will tell you that disinvesting during times of uncertainty is a bad idea. Ultimately, staying the course is one of the best investment decisions you can make over the long term, even though it may not feel like it at times. 

Having said that, sticking with an underperforming service for the sake of consistency can be an expensive mistake in and of itself. It has never been easier (in most cases) to transfer an ISA or a pension, with most good wealth managers handling the process for you. We’d recommend not obsessing over short term performance, but rather checking in periodically to ensure that you’re getting the most out of your money. 

Once a year, for example, investors should sit down and assess their financial situation. A lot of people find that the run up to the end of the tax year is a good time for this, particularly if they have tax affairs to get in order. Just a few percentage points in performance can make a huge difference to your bottom line, particularly when the impact of compound interest is taken into consideration over the long term. 

So, periodically, check that your investments are perfoming relative to the industry benchmarks, that you’re not paying over the odds in fees, and that your provider is actively managing your investments. Consistency and faith are positive traits when investing, but this doesn’t have to mean sticking with underperformance. 

Choosing cash (right now)

Cash has, traditionally, been a safe bet for the preservation of wealth. Anyone looking to simply hold their money in a risk-free environment could turn to cash and be safe in the knowledge that it’ll retain its value. This is, unfortunately, not the case right now. Interest rates being below inflation means that, over time, the real value of cash holdings will go down. 

The Bank of England’s base rate dipped from 0.25% to 0.1% in March 2020 as the effects of Covid-19 were beginning to take hold. With the effects ongoing, it is likely to be some time before we see any significant increase to the base rate, meaning that cash could prove to be a poor investment vehicle over the medium and even long term. 

Put simply, where cash was one an extremely low-risk way to save money over the long term, it is currently a zero-risk way to lose real value over time. To illustrate this point, we recently performed a 10-year study comparing cash to stocks and shares and examining the returns. The results were conclusive: during this period stocks and shares represent a better long term wealth preservation and growth strategy than cash. Ultimately, we all invest to see our wealth grow. If cash is unable to offer that growth, it’s time to consider alternatives.