Three investment mistakes to avoid when building your portfolio
Even the world’s most successful investors admit they sometimes get it wrong. In a recent Time Money article, John Bogle, founder and former CEO of the US investment firm, The Vanguard Group, claimed that one of his biggest mistakes was buying individual stocks for about a dozen years in the 50s and 60s, before he realised he wasn’t getting anywhere.
Investing is far from an exact science – it can be easy to make mistakes, particularly as many investment decisions are often subjectively based on how investors hope or believe a company or fund will perform in future.
In building up their investment portfolios, and in particular their equity portfolios, there are three common investing mistakes which could potentially impact an investor’s returns:
Letting your emotions dictate decisions
Market volatility can be a common source of uneasiness and can drive investors to consider exiting an investment or stock. However, panic-selling can mean you crystallise paper losses and miss out on any potential recovery. Adapting a long-term perspective will help you avoid knee-jerk reactions when markets are volatile. One way to do this might be to look at your portfolio performance less often.
By buying and holding your investments for a period of at least five years (though preferably longer), you may improve your probability of experiencing peak performance periods instead of trying to time the market.
There are other emotions which can also prompt you to make investment mistakes.
For example, a long bull run may make investors over-confident, particularly if their portfolio has made significant gains.
When your confidence starts to grow, keep in mind that past performance should never be seen as a guide to the future, and that market conditions can change overnight.
Surges in confidence may cause you to take unnecessary risks, so remember to consider your approach to risk when you first started investing. Your portfolio may need rebalancing over time as your asset allocation can change because of the way your investments perform.
For example, if you began with 15pc of your portfolio in shares and they have performed well in recent years, you might find they now account for a much greater proportion of your portfolio.
You might therefore decide to reallocate some of your money to other assets to help spread risk.
Simply rebalancing back to the percentages you started with means selling those assets which have done most well and buying those which have done less well.
It reinforces a good ‘sell high and buy lower’ behaviour while not encouraging market timing or pulling all money out of the portfolio.
Trying to time the market
Many are familiar with the stock market adage to buy low and sell high – however, trying to time the market is not always straightforward.
No-one is able to fully decipher the direction markets will move in future and withdrawing at the wrong time could result in the loss of potential future returns.
If you’re worried about markets taking a sudden dip just after you’ve invested a lump sum, investing regularly can help smooth out market volatility. When you incrementally invest money monthly, you buy more shares when prices are low – and fewer when prices are high, effectively meaning you pay the average price over a fixed period. As you’ve committed to investing regardless of market conditions, this can help remove some of the emotion from your investment decisions.
Failing to diversify
Focusing excessively on one particular asset class, sector or geographical area could mean that if any of these fall in value, it may have a disproportionate effect on the value of your portfolio.
It’s therefore important to ensure your investments are properly diversified. This lessens the potential for losses, as it’s unlikely – although not impossible – that all the main asset classes will lose value at the same time.
Having exposure to a wide range of companies, industries and types of market from different regions around the world means that even if a few of your investments underperform, hopefully some of your other holdings may rise in value, offsetting some or all of your losses.
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