Investment Trusts

Six common investment mistakes and how to avoid them

The world of investing can be both exciting and very rewarding - but it’s not without its potential pitfalls. So it’s important to arm yourself with as much information as possible to make sure you choose the right investments. Here are some of the common mistakes many investors make and how you can avoid them.

13 Sep 2017

John Spedding

John Spedding

Head of Investment Trusts

Contributes to
Unstructured Learning Time

CPD Accredited

Mistake 1 - Trying to time the market

In the words of renowned economist J K Galbraith, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know”. 

It is hard to establish the best time to buy (and sell) shares and funds. So a sensible investment strategy can be to develop the habit of investing money each month regardless of market conditions and set up a monthly savings plan. By drip feeding your money into the market each month, known as pound cost averaging, the effects of the highs and lows are smoothed. You buy fewer shares when prices are high and more when prices are low.

Mistake 2 – Missing opportunities

There are, however, some occasions when it can be a good idea to consider  putting larger sums into the market, if you have money to spare. For example, if you have a long-term investment horizon you may have the opportunity to pick up good investments at cheap prices after a heavy fall in the market, benefiting from the panic selling of others.

Mistake 3 - Not doing your homework 

Many people make the mistake of investing without fully understanding what they’re buying. This means they don’t appreciate the possible risks and rewards. Make sure you look under the bonnet of where your money is going.

Look at what the fund invests in and its objective to give you an idea of the returns and level of risk. You can study performance figures of funds you are interested in which will allow you to gauge how the fund - and investment team - has fared so far. But don’t be entirely guided by them. Past performance is no guidance to future performance.

Remember that big is not necessarily best. Funds that attract the largest amount of money are often seen as safe bets. But that’s not always the case. You should also understand the charges that are taken out of the fund.

Mistake 4 - Putting all your eggs in one basket

Diversification is key to any investment portfolio. When you hold a basket containing a large number investments in different  asset classes, losses from any single investment shouldn’t have too large of an impact on the value of your portfolio as a whole. Your overall returns should be also be smoother as in conditions when some   asset classes tend to perform badly, others tend to do well.

To build a well diversified portfolio you could consider investing in a blend of equities, bonds, cash, and alternative asset classes such as property.

You should also consider diversification when selecting funds. Holding a number of popular equity income funds for example is unlikely to give you much of a diversification benefit as the investment holdings in these funds are often similar.

Mistake 5 – Neglecting the impact on capital in the pursuit of income  

The return from an investment is made up of a combination of income and capital growth. With a bit of number crunching it’s clear that income can sometimes come at the expense of capital. So make sure that you understand how taking income from a portfolio could affect your capital over time and remember that any income you take from an investment is not available to generate future growth.

Mistake 6 - Neglecting your investments

Investment planning should not be a one off event but part of your financial planning agenda throughout your life. Over time it’s likely that your circumstances change and this may well have an impact on your investment objectives and risk appetite. So it’s important to regularly consider whether any fund holdings you have build up over the years remain right for your needs.

Equally, markets and asset classes don’t all move in a straight line, so over time your exposure to different investments will change. This means your investments may have become higher – or lower – risk than you actually want.

Check your asset allocation and if necessary rebalance to reflect your current goals and attitude to risk. You should also keep an eye out for funds that are consistently underperforming. Understand why, and don’t stick with paltry returns for the sake of it.

While it is important to monitor how your portfolio is performing, the point of buying funds is to let the professionals worry about market movements. Experts recommend ignoring short-term noise and making sure you stick to your long-term investment strategy and goals.

Why consider an investment trust?

Investment trusts have a number of unique features that could help you achieve to achieve your objectives.  

Long-term focus

An investment trust is not subject to inflows and outflows of investors’ funds. This allows the fund manager to make truly long-term investment decisions in the interest of shareholders, without having to worry about holding sufficient cash to meet redemptions from the fund.

The ability to borrow

Unlike unit trusts, investment trusts are allowed to borrow, so if a manager thinks there is value in a particular market, he or she can borrow money to use for further investments. This is known as “gearing”. It is important to note that gearing can add risk as it will increase returns if the value of the investments purchased increases by more than the cost of borrowing, but reduce returns if they fail to do so.

Dividend smoothing

Investment trusts can smooth dividend returns by holding back up to 15% of their dividends each year, allowing them to hold back returns in the good years to top-up payouts in difficult years. This means that some have very long records of raising dividend payments year in, year out.

Please remember that past performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. 

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