The good news is that it’s never been easier to take control of your future and invest your own money. The FCA and the government are forcing the investment industry to be more transparent and deliver better outcomes for investors. It means that there has never been a better time to start investing and saving towards your future goals, whether it be a home, your retirement or your children’s future. If you are making any of these five common investment mistakes here’s how to fix them:
1 - Ignoring costs
When you invest your money there are a myriad of charges taken from your investments. If you want the best chance of achieving your investment goals then you need your investment portfolio to grow as quickly as possible. By revinvesting that growth you benefit from the snowball effect of compounding. However investment, charges diminish the effect of compounding by taking a percentage chunk out of your investments each year. If you ignore costs the only way to counter the impact of the charges is to invest more money.
What it’s costing you
Each year this can include an adviser's fee of up to 1% of your portfolio alongside additional investment funds fees (1.5%) and platform fees (of around 0.5%). That means that you need to earn 3.5% growth a year just to pay the charges and stop your portfolio shrinking. That is very high.
Assume you had an initial investment worth £50,000 where the underlying investment funds grew at 7% a year before charges. After 20 years, and assuming total charges of 2.5% per year your portfolio would grow to £117,292. However if you had cut your total investment charges to 1.5% then your portfolio would be worth £158,398. That’s a massive difference of £41,106, which is almost as much as your initial investment, just by not ignoring the charges you pay.
How to fix it
It has never been easier to invest your own money using a range of online investment services and products. By running your own money you can avoid the needless cost of adviser charges, assuming you are comfortable making your own decisions, which would save you up to 1% a year. In addition by shopping around and finding the cheapest investment platform you can reduce the platform fee. Finally keep an eye on fund charges. That doesn’t mean just focus on costs because there is an interesting dynamic between fund performance and fund costs. As the price of a fund falls the performance of the fund (after charges) doesn't rise by a corresponding amount. In fact research by 80-20 Investor proved that the sweet spot for performance vs charges is just under 1% per annum. So if you ensure you keep your fund charges below this level you increases your chances of outperforming,
2 - Buying and holding funds
The investment adage 'time in the market is more important than timing' the market does have an element of truth in it, but be careful because the biggest advocates actually have a vested interest in you following it. Investment fund companies, platforms and financial advisers can only make money by charging a fee on your investments if you keep it with them. If you decide to encash your investments and sit out of the market for a bit they can't siphon some of your money. Typically investors will buy a fund and forget (aka buy ad hold) about it, holding it for at least 7 years during which point the advisers will be happy as they earn from you while providing little or no service.
What it’s costing you
If for example at the start of 2011 you invested in the top 10 best performing UK equity funds from the previous 10 years and held them for the next 5 years (between 2011 to 2016), where do you think each of those funds typically ranked out of the 212 funds UK funds for performance between 2011 and 2016? While you might not expect them to once again represent the top 10 but you'd be shocked to learn that the average rank (for performance) of those funds was 78 out of 212 UK equity funds. Many of these 'buy and hold' funds fell into the bottom half of the performance rankings. Yet your charges didn't' fall. You kept paying for that underperformance.
How to fix it
The solution is actually fairly simple. You need to regularly review your portfolio and make fund switches (if necessary) to take advantage of prevailing market conditions. Remember every dog (fund) has its day. A buy and hold strategy is akin to pointing your surfboard in the direction of the beach, closing your eyes and hoping for the best while your adviser and fund managers watch from the beach eating the picnic you've paid for. Later in this article we'll cover how to review your funds.
However, if you do want to buy and hold a portfolio of funds then here is some research that show the perfect ISA portfolio that has made a profit every year since the market peak of 2000.
3 - Picking between active and passive investments
When investing in funds you have the option of investing in passive or active funds. Passive funds are typically run by computers and will track a market or index. They typically have very low costs but by definition they can't outperform the market they track. In fact they will slightly underperform because despite their costs being low it sill drags on the performance. Active funds on the other hand are run by fund managers and are much more expensive and tend to underperform the market over the long term. There is a lot of argument over whether active funds or passive funds are the best to invest in. Yet, every research white paper I've seen that claims either methodology is better than the other always makes the flawed assumptions that a) you don't invest in both and b) you buy and hold the funds. In addition each side of the debate usually has a vested interest (i.e. they sell active or passive funds) in shifting the argument one way one the other. The truth is that investing in active and passive funds at the right times is a better strategy.
What it’s costing you
To demonstrate this I've invested £50,000 of my own money in a portfolio of funds, which I regularly review, that includes both active and passive funds as and when appropriate. Since March 2015 alone my portfolio has made a profit of £10,445. An equivalent passive only portfolio made a profit of £8,385 while an equivalent active managed portfolio made £7,405 profit.
How to solve it
Do not limit your investment options based purely upon a debated created by companies trying to sell their own funds. .
4 - Being emotional
The most successful investors in the world have the ability to take the emotion out of investing. The two main emotions which investors tend to be driven by are greed and fear. Greed encourages you to chase profits and speculate. Speculation is where you invest in something in the hope that it will make a profit. Hope is not a reliable investment strategy. Conversely fear causes people to sell out when markets fall, sometime needlessly crystallising losses, only for it to rebound. Usually the knee-jerk response to an event, based upon emotion, is often the wrong one.
What it’s costing you
Being a successful investor has very little to do with intelligence. You'll be surprised to know that Sir Isaac Newton was almost ruined by his own greed, In 1720 the hottest shares at the time were those of the South Sea Company. Having banked a small profit from an earlier investment in the company Newton watched as the share price went through the roof. Unable to bear it any longer Newton invested back into company at a much higher price. The South Sea Company shares were forming a bubble which eventually burst losing Newton the equivalent of £3 million in today's money.
Fear is just as damaging to a portfolio. Act too swiftly in a stock market sell-off and it can take you years to recover. In fact our independent research shows that stock markets tumble they typically rebound six days later. Furthermore it also quantifies the likely size of any rebound.
How to solve it
We have no control over what happens in investment markets. So how do you avoid making costly emotional decisions? Studies have shown that if you focus on process rather than outcomes it leads to better decisions. This is also true in investing and has been shown to maximise the potential to generate good returns over the long-term because it encourages objective fact based decisions.
5 - Investing in what you think will make money rather than what is most likely to
The reason why you we are poor at predicting the future is something called confirmation bias. It's the tendency for us humans to put more faith in information that agrees with what we already believe and to ignore opinions and data that disagree with this belief. Confirmation bias even means that we tend to invest in the things we think will make money rather than what is most likely.
What it’s costing you
You only have to go back to the Brexit referendum in 2016 for a beautiful example of how trying predict the future will cost you. Fund managers, along with most political commentators, were predicting a win for the Remain vote. As such fund managers bet on the pound rallying and a boost for the UK economy. In fact when the UK electorate voted to leave the EU the pound plummeted in value catching out those who bet on a sterling rally. In the immediate aftermath fund managers moved to correct their positions and were left behind as a result.
How to fix it
Momentum investing is the act of riding unfolding trends which are working in the current investment environment and is one of the few investment strategies to consistently outperform other strategies over the long term, as proven by countless academic papers. One of the most influential was that produced by Jegadeesh &_Titman in1993. The key is identifying the latest trends and riding the best and strongest of those until they’ve run their course or better opportunities present themselves.
The problem has always been that momentum analysis can be time consuming and the volume of data required to do it means that only professional investors and institutions have access to it. However, 80-20 Investor does all the data crunching for you to provide fund shortlists. If you click on the following link you can see how 80-20 Investor even applied momentum to ride the underlying trends around the Brexit vote (in June 2016) to make more than 5% in 2 days.
Finally, I have produced a short email summary of that teaches you what makes a successful investor based upon academic research, our own professional investing experience and fund manager interviews.
