Six common investing errors to look out for
Successful investing helps to deliver the financial answer to one of life’s most fundamental questions: what do we want to achieve?
For many people, this distils down to two things, to live well, and to leave a good legacy. From this perspective, investing, done right, can be a huge enabler. There are, however, pitfalls and investing errors to avoid along the way. Taking the time to educate yourself about these can reduce unforeseen risks and help to maximise your wealth over the longer term.
Tim Bennett, Head of Education at Killik & Co, shares six of the most common investing errors which should be avoided to increase your chances of successfully achieving your financial goals.
Not diversifying a portfolio
No stock is immune from single stock risk. Take BP as an example. Up until 2010, it was the largest stock on the UK equity market and the biggest dividend payer. However, this all ended abruptly with the Deepwater oil spill. This episode reveals that no firm is too big to fail and underlines the importance of diversifying by spreading your money around different investments to help to mitigate the impact of one suddenly running into short-term trouble. It is important to note, however, that even fully diversified portfolios are not, by extension, shielded from a widespread market crash.
Opinions vary on how many stocks you should hold as a minimum – at least 20–25 will significantly reduce single stock risk.
Spending dividends
Dividends are attractive because they provide a short-term, known cash return on your investment. However, to help you to build long-term stock market wealth you should reinvest them in more shares, as they are declared and distributed, rather than spending them. Several well-known surveys of stock market performance suggest that this approach can add significantly to your long-term total returns.
Being ruled by emotion
As humans, we are often irrational and are prone to being ruled more by our hearts than our heads. This is not helpful when investing.
There are many examples. People sometimes buy low priced “penny” shares in the belief that they “can’t get any cheaper”. Yet any share, even one priced at just a few pence, can still cost you 100% of your investment should it subsequently drop to zero.
Equally, it can be hard to keep away from a share that has already multiplied in value many times but if your analysis does not support the current price, then you should stay away rather than piling into a stock that may be overpriced.
Being too systematic
Some investors devise share-trading systems, partly to overcome their emotional biases, but then become trapped by them. For example, an investor who profits by automatically selling a stock once it rises by a fixed amount will never “run a winner” that might return many times more than that. In doing so they are systematically limiting their potential upside.
Following the crowd
Those investors who always wait to follow the crowd will tend to buy after everyone else and sell after them too. This is the opposite of what successful investors should be doing as it results in the “buying high” and “selling low”. They will often then compound this problem by trading more often than they should and incurring extra costs. A better approach is to stick to a long-term strategy and not get distracted by other people.
Anchoring to irrelevant information
Investors can be prone to latch onto past data points that no longer reflect current market conditions. An example is the price they pay for a share. If a company is in trouble, the share price may never return to its previous level, yet some investors hang on grimly hoping that it will. Equally, some investors are deterred from investing at all by short-term volatility and can end up sitting on the cash for far too long as good opportunities to earn a better return pass them by.
By Tim Bennett, Head of Education at Killik & Co