How to become a better investor: 10 common mistakes to avoid
Over the years we’ve noticed a few common mistakes made by DIY investors. Jason Hollands – our award-winning market commentator – shares his insights so you can keep your investments on track. And if you feel like your portfolio has gone off the rails, Jason's useful suggestions can help you become a better investor. All you have to do is read on...
Written by Jason Hollands
Published on 06 Jul 202213 minute read
According to research group Boring Money, as at the end of 2021 some nine million accounts representing assets of £378 billion, had been opened by UK ‘Do-it-Yourself’ investors – those who make their own decisions without taking financial advice [1].
Many DIY investors are confident and knowledgeable about investing and enjoy reading up on shares, funds and investment companies and articles on the outlook for the markets. But that isn’t universally the case, with others seeking more help with their decisions. And for a few, the experience of DIY investing conjures up the image of a botched decorating or plumbing job – with decisions that go wrong, sometimes irretrievably.
1. Set goals
Plenty of studies have indicated that people who invest with clear goals in mind get better results. Bestinvest recently commissioned its own research, which strongly indicates that most people understand this, with 80% of investors surveyed stating that they believe that investing with a goal in mind will lead to better results [2]. Having a goal like retirement, buying a property, or saving for education fees, helps focus the mind on a timescale, the level of return needed to achieve a goal and the amount of risk that might be appropriate.
But there are also plenty of investors who don’t have a goal in mind and invest with simply the hope that the value will rise. This can be like embarking on a journey without knowing the destination!
2. Have an asset allocation plan
Diversification – spreading your money around different investments – is an important principle for successful investors. It both widens access to different opportunities and helps reduce risk by not leaving you overexposed to any single investment that might not work out. Different types of assets such as equities, bonds, infrastructure, gold, property and cash will react differently to the changing economic and financial environment. So blending a combination of these – a process known as asset allocation – is key to getting an appropriate balance between riskier, but potentially higher-return investments, and those that are less volatile, or which might hold up better in tougher times.
Academic studies have demonstrated that asset allocation is the biggest driver of differences in returns between investment portfolios, more so than the individual stocks and bonds selected [3]. Professional investors therefore spend both time and resources thinking about asset allocation and how it might evolve depending on the market outlook.
However, a common mistake by DIY investors is to overlook asset allocation in the clamour to pick funds or shares. This can unwittingly expose them to high levels of risk, so thinking about asset allocation is important before diving in and buying investments.
3. Understanding risk
Taking too much risk is a common problem among DIY investors, but so is not taking enough risk. Less confident investors can be overly cautious, such as holding too much cash or bonds, which may mean they’re unlikely to achieve their longer-term goals.
We live in a world where ‘risk’ is perceived as danger and something to be avoided. But when it comes to investing, there is a relationship between risk and reward that needs to be carefully assessed and managed. Without taking any risk, it is near impossible to generate a real return once inflation is factored in. What matters is to take an appropriate amount of risk rather than avoid it altogether.
Time is an important factor here. The more time you expect to be invested, the more capacity you might have to take a greater amount of risk, because there will be time to recover from any market declines on the way. Periods of falling markets, known as ‘corrections’ (a decline of 10% or more) or ‘bear markets’ (a decline of 20% or more) periodically happen and are something people should expect to experience at some point during their investing lives. Historically, bear markets have typically happened twice in each decade.
Conversely, if the time horizon when you expect to draw on your investment is shorter, such as less than five years, then a more cautious approach is very wise as you may not have sufficient recovery time available if markets take a sharp setback. We believe that goal-based investing leads to better outcomes, because it helps an investor identify the level of return aimed for over a certain period and therefore the appropriate level of risk.
Over the long term, equities have generated the highest returns among the major asset classes, but stocks can also be volatile. Volatility – the extent to which an investment fluctuates in value – is a key measure of investment risk. In constructing an investment portfolio, having a longer time horizon should mean greater capacity for exposure to equities. Less volatile asset classes such as bonds, targeted absolute return funds and cash can supplement equities to reduce overall volatility.
Volatility is not the only form of risk to consider. Exposure to assets that can be difficult to sell in a hurry, such as shares in very small companies, unquoted companies, or physical property, may not be volatile but represent a different form of risk known as liquidity risk. Exposure to illiquid investments that you may not be able to sell quickly if you need your money back, should be avoided by those with shorter time horizons.
4. Avoid making ad hoc decisions
Successful investors think carefully about the right asset allocation for their time horizon before deciding which funds or shares to choose. When it comes to deciding where to invest additional money, they will firstly review where their existing portfolio is invested and identify any gaps or weaknesses that might be filled with new investments.
However, some DIY investors regard their annual ISA or pension contributions and investment choices as ad hoc, standalone decisions to take each year. It can be tempting to pick whatever investments are currently doing well, are being heavily tipped or are in fashion. These ad hoc purchases can gradually add up to create ‘museums of former hot tips’ rather than a well-crafted portfolio that will help them achieve their goals. Before investing additional money, it is sensible to look at where your current investments are exposed. This can help identify the areas where new investments might be made.
5. Focus on the future, not just the past
It would be risky to take a car journey and stare solely in the rear-view mirror at the expense of the road ahead. Unfortunately, it is the way some go about selecting their investments ie, solely based on past performance without considering the prospects.
Investment approaches and sectors come in and out of favour depending on the market environment. For example, the sectors that typically do well when inflation and interest rates are low, or when the economy is booming, are not the same as when inflation or borrowing costs are rising. So, choosing investments requires a mixture of considerations, not just how well a particular share or fund has done in the past.
Funds can also become victims of their own success, swelling in size so that they may no longer be able be managed in as nimble manner as they were in the past or requiring major changes to their approach.
6. Avoid mis-selling… to yourself
A risk facing investors who don’t take professional advice is that they mis-sell to themselves, getting enticed by highly specialist investments that may have delivered strong returns in the past, but which are inappropriate for their risk profile and circumstances. This could mean investing too heavily in niche or high-risk sectors, such as biotechnology, shares in tiny companies or frontier markets etc. It is easy to get excited about specialist areas and throw all caution to the wind – especially when there isn’t someone advising you of whether these are appropriate – so don’t lose sight of the risks involved.
It's a good idea to remind yourself that investments can go down as well as up, and you can get back less than you originally invested.
7. Don’t let emotions override your judgment
Short-term market movements are heavily swayed by changes in investor sentiment. It is all too easy to allow decision-making to be driven by our emotions. Indeed Warren Buffett, the legendary US investor, famously observed that investors should "be fearful when others are greedy, and greedy when others are fearful”, such is the pull of emotions on investing behaviour.
When markets are soaring and optimism is high, investors can get swept up with exuberance and tend to think less about risk than they should and are happy to pour money into the markets. But when markets hit a downturn or the economy heads towards a recession, there is also a tendency to panic, stop investing or cash-in completely which potentially crystallises losses. For long-term investors it usually makes sense to invest further when markets have fallen sharply and share prices are lower than when prices are at record highs – though it often feels uncomfortable at the time. When the prices of goods such as clothes and electrical goods are slashed in the January sales, people clamour to pick up a bargain. Curiously, an opposite mindset kicks in when financial markets slide!
When your life savings take a sharp fall in value, it is difficult to overcome the pull of emotions and stay calm. During times of volatility and uncertainty, confidence in investment decisions often wanes. One way to overcome this is to invest regularly and consistently, such as through a monthly scheme. This will keep you going through the market ups and downs and over time, steadily build the value of your investments.
8. Rebalance regularly
While many investors will initially carefully plan a portfolio at the outset, it is also vital to continue monitoring a portfolio afterwards and make sure that it is periodically rebalanced.
Different markets and asset classes won’t all move ahead at the same pace. This means that over time, carefully selected weightings to each will drift and so the risk profile of an investment portfolio can gradually change, potentially no longer being appropriate for the investor’s goals. Having identified the appropriate asset allocation approach for their time horizon and goals, an investor should periodically rebalance their portfolio.
This will mean trimming gains in those areas that have surged ahead and become a much larger part of a portfolio than originally intended and topping up other areas to retain a balanced approach.
9. Don’t hold too many funds
Alongside rebalancing a portfolio, it is also important to review individual investment choices every now and then to make sure they still deserve a place in your portfolio. The tendency of some investors is to shop around each year for exciting new investment ideas, but this can mean their portfolios eventually end up with a vast number of holdings, some of which may be long forgotten. In the investment world this is referred to as having a ‘long-tail’ of holdings that are somewhat overlooked.
It is hard to keep an eye on a portfolio with too many holdings. While diversification is important, you can also be over-diversified too which has earned the nickname ‘diworsification’! Some investors can be reluctant to switch out of funds or shares that have disappointed, hoping they will eventually come good again because they have become emotionally invested in their choice and would rather not admit it was a wrong one. In reality, they may be better able to make up lost ground by moving elsewhere.
A good discipline is to set yourself a limit on the number of funds or trusts to be held. For example, Bestinvest’s ready-made portfolios will typically hold between 15 – 20 funds. By setting yourself a limit like this, it forces you to reassess what you already hold and consider whether any of your existing holdings should make way for any new ideas that you might consider. If you have a well-diversified portfolio of investments that you are comfortable with, then additional cash to be invested can be used to top those up.
10. Don’t get too attached to any one favourite fund
When a fund or investment trust has done really well, handing them more of your hard-earned money seems a sensible move and to an extent this is right. However, becoming too heavily exposed to a manager or investment approach can also become risky. Their style could go out of favour, their fund could become too large, or they may lose the Midas touch. As a broad measure, avoid having more than 15% of a portfolio in a single fund or trust.
The investment industry is notorious for ‘star managers’ attracting personal fan clubs. But sometimes those stars end up as shooting stars that crash back down to earth. What matters more in our view is that a manager has a clear investment approach that can be monitored and assessed. If they start to deviate from it, this might be an early sign of trouble to come.
If you are going to invest in actively managed funds or trusts – those where a fund manager is tasked with using their knowledge and skills to try and pick investments – it is important to keep an eye on who is in the driving seat. Fund managers can change companies, get promoted into managerial roles with additional responsibilities, and of course retire. When the team changes on a fund or investment trust, it is always a time to reassess the case for continuing to hold it, or whether it might be time to move on.
Another way to invest...
Building and managing your own investments can be rewarding and many people, as well reaping financial rewards, also develop a real interest in the investment world. However, not everyone has the time or inclination to manage their own investments. If the thought of building, monitoring and rebalancing a portfolio seems daunting or simply does not appeal, there are other options.
For those looking for an easier solution, a ‘ready-made portfolio’ might be the right option. These are professionally managed portfolios, designed to meet a risk profile and broad objective like growth or income, which provide access to a diversified range of underlying investments selected for the investors. The choice of investment, asset allocation and rebalancing are done for you.
In the case of Bestinvest, we offer ready-made portfolios to suit different goals and risk profiles, including sustainable investments. Alongside our Expert range, which predominantly invest in actively managed funds, we also offer a Smart range of five low-cost portfolios with ongoing costs of between 0.34% and 0.37%. All our ready-made portfolios have a highly competitive account fee of 0.20% for amounts up to £500k (0.10% for balances between £500k and £1 million).
In addition to the new low-cost Smart portfolios, the Bestinvest platform has also recently relaunched with several other new features to help DIY investors become better investors:
- The ability to book a free investment coaching session online with a qualified financial planner who can provide help and guidance
- The ability to complete an online risk assessment questionnaire to enable investors to identify their risk profile
- The rollout of new digital goal planning tools, starting with a retirement planner, that enables investors to set a goal, measure progress to achieve it and identify potential actions to get on track. Further tools are coming soon to help with other goals such as education fees and buying a property
- And where personalised advice is required, Bestinvest have introduced some bite sized, fixed price advice packages which do not require investors to take ongoing financial advice
Sources
[1] Boring Money Online Investing Report, February 2022.
[2] Bestinvest Life Goals Study surveyed 2,000 people across the UK between the ages of 18 to 65+. The survey was carried out by global market research firm 3Gem between May 13 to May 18, 2022.
[3] One of the best-known studies is Determinants of Portfolio Performance (1986 and 1991, Brinson, Hood and Beebower) which found 90% of variations in US pension fund performance were down to asset allocation.
Important information
This article is solely for information purposes and is not intended to be, and should not be construed as investment advice. Whilst considerable care has been taken to ensure the information contained within this commentary is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information. The opinions expressed are made in good faith, but are subject to change without notice.
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