The main drivers of saving are to live well or leave behind a significant legacy and if done right, investing can create a smooth path to these ambitions.
But it doesn’t mean there won’t be obstacles along the way, says Tim Bennett, head of education at Killik & Co.
Investors should always try to educate themselves about the unforeseen risks, or turn to their financial advisers to discuss them, and maximise their wealth over the long term.
Bennett identified six common mistakes people should avoid to make the most out of their investments.
No firm is ‘too big to fail’
First, diversification is key.
“No stock is immune from single stock risk,” Bennett said. “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.”
There are several options available on minimum stock holdings, but he believes that at least 20 to 25 will significantly reduce single stock risks.
Think and reinvest
Second, do not spend your dividends.
Bennett said that dividends are very attractive as they provide short-term cash on people’s investments. But they should be reinvested in order to build longer-term stock market wealth.
Additionally, investment decisions “are not a matter of the heart” so, third, don’t let yourself be ruled by emotion.
Even though, as people we are prone to following our emotions and instincts, a rational train of thought will likely bring more positive outcomes.
He said: “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.”
Find balance
Fourth, being too rational or systematic can carry the same risks as being too impulsive in making investment decisions.
Bennett said that some investors “devise share-trading systems” in order to overcome their emotional biases, but then end up being trapped by them.
This is because an investor who usually profits from automatically selling a stock will never hold on to one that may return many times more the fixed sum they raised through the sale.
“In doing so, they are systematically limiting their potential upside,” he added.
Similarly, fifth, following what others are doing – GameStop being one of the most recent and biggest examples – can be just as detrimental to an investor’s wealth creation and accumulation process.
It is so as people will often buy after everybody else have, and sell after them as well; meaning that they are not only buying a more expensive stock, but also selling at a lower price that they could or should have.
“They will often then compound this problem by trading more often than they should and incurring extra costs,” Bennett added. “A better approach is to stick to a long-term strategy and not get distracted by other people.”
Past vs present markets
Different investors will base their decisions on a plethora of sources and information. But, finally, people should be wary about what data they rely on and whether it is relevant to their circumstances.
Bennett said: “An example is the price they pay for a share – if a company is in real trouble the share price may never get back to its previous level, yet some investors will 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 side lines in cash for far too long as good opportunities to earn a better return pass them by.”
