Avoid investment traps

Annie Shaw / 24 September 2015

Annie Shaw looks at the common mistakes people make when investing and gives her tips to make the most out of your money.

The new pension freedoms and increased allowance for ISAs (individual savings accounts) are great news for people who want to make the most of their money, but sadly this also means the freedom to make mistakes, many of which will be irreversible once we reach retirement.

Here are some of the main investment traps – which can catch people out at any age.

Getting caught up in cash

The biggest mistake people can make in respect of investments is failure to invest at all.

People who are risk averse and don’t really understand how to make the most of their cash are in danger of simply leaving it in the building society, where it can be ravaged by inflation and low rates of interest.

Of course, maintaining an easily accessible cash fund is a keystone of prudent money management, but for larger sums leaving money to wither in a cash account will rarely give the best returns.

Slipping into the confidence trap

While many people are quite at home managing their money, and many are happy to do their own research and even take risks in search of rewards, some investors can be overconfident, particularly if they have had a lucky run.

Managing money in retirement can be quite different from managing money during a working life, when wages can make up losses resulting from mistakes.

Flying solo

A qualified adviser can not only help you meet your investing objectives because of their expertise – you also gain valuable consumer protections if things go wrong. That is something not always available to do-it yourself investors.

Do you need a financial adviser? Read Annie Shaw's tips.

Losing your way in the money maze

It is important to have an investment strategy and make regular checks that your objectives are being met.

An adviser will do this for you, but if you are investing for yourself you need to keep an eye on things to make sure that all is going to plan. For instance, if your plan is to supplement pension income, you need to ensure that your portfolio is doing this and, if it is not, change your strategy or adjust your spending.

Putting all your eggs in one basket

Always spread your savings around various asset classes, including shares, property, fixed interest and investment funds. The proportions you have in each class will depend on your attitude to risk and your investment objectives.

Curious about what Saga Share Direct can offer you? Find out more today...

Trying to make a quick win

Never attempt to make profits with a lump sum by trying to time the market. If you make your investment at the wrong time, you could find yourself suffering an immediate loss if the market has just peaked. You can avoid this by drip feeding money into your investments, taking advantage of a phenomenon known as “pound cost averaging”.

Rather than trying to get as big a return as possible all at once – an almost impossible task – you feed your cash into your selected investments bit by bit during various stages of the investment cycle. This gives you a “fair return” by smoothing out the peaks and the troughs. You may miss out on an immediate gain but you avoid a disastrous fall, too – a much safer strategy.

Getting caught in a scammer's web

Beware scams and traps. Your fraud antennae should automatically start twitching if someone cold calls you. No respectable investment company would ever phone to sell you dodgy investments, such as carbon credits, car parking spaces, fine wine or parcels of land for property development

As the saying goes, if an investment looks too good to be true it probably is. If you don’t understand something, avoid it. Never be fobbed off by a pushy salesman or glossy literature. Never give bank card details over the phone. If you can’t explain how a scheme works in words of one syllable, you could be at risk.

Read Paul Lewis' guide to pension scams.

Trying to turn base metal into gold

Avoid “investment courses” that claim to teach you the “secrets” of successful investing in anything from foreign exchange to day trading or property.

Ask yourself why these course promoters are not keeping the secrets to themselves to make more money. The short answer is that these “secrets” don’t exist, and the operators are making their money by selling you the course, or relieving you of your cash to place in their own dodgy investment.

Not understanding your risk profile

Attitude to risk varies according to circumstances, and you need to understand yours. Be realistic about how much you are prepared to lose in exchange for the thrill of seeing an investment rise.

Financial advisers use psychometric tools and questionnaires to score their customers for risk tolerance. You can also find tools online, such as the one offered by Rutgers University in the US.

If you are generally risk-averse but enjoy managing your money and want to do more than simply tuck it away in a safe account, you could adopt a strategy of splitting your savings into a secure fund and a “gambling” fund, so you can have some financial fun without fear of losing your shirt.

Someone with an occupational pension or an annuity as a bedrock for meeting their living costs would be less exposed to risk than someone who was endeavouring to live solely off savings that they had to manage themselves.

Failing to cut your loses

Research shows that people typically strongly prefer avoiding losses to acquiring gains. But when you are investing you can’t afford to be sentimental. Sometimes you just have to cut your losses and move on.

That said, you shouldn’t panic and sell up when the market falls, as this only crystallises your losses.

If you have a financial plan and a balanced portfolio, cutting losses should only be a matter of weeding out non-performing funds, shares or assets.

Do your research and, when deciding if you should sell a dud, ask yourself “would I buy this share today?” If you wouldn’t, then it’s a candidate for disposal.

Losing your balance

This is a tricky one, because while the music is playing you want the party to continue. No one wants to sell when they are making money, but clever investors bank their gains. This is because success in a particular asset class or share could make you “overweight” in that asset, exposing you to risk that you don’t want to take that the investment subsequently falls.

As well as weeding out the bad performers, rebalancing means taking profits, to ensure that your investment objectives are being met.

Misreading the crystal ball

Every investment firm puts a warning on its literature against using the past as a guide, but many investors ignore it. You can’t tell if it will be sunny tomorrow by looking at last week’s weather report. Certainly there are trends and cycles, but markets also move on, so don’t get caught out looking backwards.

Falling under a spell

If anyone tells you “This time it’s different”, remember that it never is. There is no substitute for using common sense, trusting your instincts and doing your own research.

Listening to rumours and tips

Wall Street stockbrokers used to say that if their taxi driver was tipping a stock it was certainly time to sell – if they hadn’t sold already. By the time you read the tips in the newspapers you are probably too late to climb aboard.

Beware of internet tips and rumours. Scammers put a lot of effort into ramping shares they hold on bulletin boards and other social media.

Going crazy for tax breaks

While you should take advantage of the tax breaks available to you, such as saving within a pension fund or an ISA, never buy or hold an investment solely because of its tax advantages.

The tax situation should form part of the investment profile and should enhance the return. It is no good holding something with a poor return just because of its tax status. You might be better off paying tax if it enables you to pocket a higher net figure.

Being put off by costs

The cost of investing, whether it’s dealing charges, the fee for advice or the cost of the investment platform, is all part of your investment profile.

Keep an eye on costs to ensure that you are not overpaying – particularly if you can find an identical service elsewhere more cheaply – but don’t be afraid to pay more if you get superior returns or a service that meets your needs better.

Annie Shaw writes a monthly column for Saga Magazine. To read more of Annie's articles, delivered to your doorstep, subscribe here. 

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.