Do trade your best ideas, but don’t mismanage your wealth

Evidence shows that the average investor underperforms the investment indices, by buying at market peaks and selling at market troughs. The good news is, it’s simple to avoid falling into this trap.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results
Trading ideas

It is an odd fact of life that market commentators who predict financial collapse, offering grave warnings about the state of the economy, are given large amounts of airtime, and are looked on as wise elders, while those of a sunnier disposition are often dismissed as ‘not understanding economics’, or accused of ‘having something to sell’.

The history books tells us, perhaps apocryphally, that Roman generals would have a slave during processions whisper into their ear, ‘Remember, you are mortal’. In this respect, the modern day heralds of doom have a role to play - it has been all too easy to make money over the past eight years by throwing caution to the wind — but persistent calls in the newspapers and on the television by commentators to sell everything and hunker down are unhelpful for long-term wealth creation.

Most UK share dealing platforms have large amounts of cash as a percentage of their Assets under Administration (AUA), a number which doesn’t really fluctuate much over time. This is because human psychology makes us cautious: when markets rise investors think they are bound to crash, and when they fall investors think they have further to go.

History shows that market crashes tend to be brief events, while mankind’s ability to grow the global economy has helped investors in equities consistently make strong inflation-adjusted returns, over long periods of time. 

The evidence against the average investor is strong

JP Morgan Asset Management produces an annual report showing the long-term returns of various asset classes and asset mixes. Depressingly, right at the bottom of this is the Average Investor return of 2.3%. 

To put this into perspective, a $5000 annual investment for 20 years, at a 7.2% return (the 60/40 equity bond split) would be worth $209,510 as opposed to $125,183 for the average investor. Over longer time periods, these are life changing mistakes. People that fail to invest effectively will find their latter life rather less comfortable than it would otherwise have been.

Year after year, investors get caught up in market fads, buying near the top and capitulating near the bottom, or attempting to catch a ‘falling knife’ that has further to drop.

A good example of the latter is Carillion, the construction company, previously a stalwart of the FTSE 250, which was rocked by profit warnings and fell 88% in the year to 17 November 2017. The share register was previously full of institutional investors, but now Hargreaves Lansdown, Barclays, TD Direct Investing, and Halifax Share Dealing make up four of the top six largest shareholders. Do retail investors know something the professionals don’t?

Carillion may prove to be a stunning investment opportunity, but it is one of many examples where retail investors have attempted — and failed — to catch the knife.

Blend your active investing with a longer-term holding

Investing in individual stocks offers great opportunity, but the pitfalls of getting it wrong, with too large a proportion of your investments, can be calamitous. Maths dictates that an investment that falls 70%, requires a rise of more than 230% to get back to break even.

Diversification is the best route to avoiding this investment pitfall, both in terms of asset allocations and in terms of who invests your money. 

The most experienced of investment professionals will manage some of their own wealth, while outsourcing the management of the rest to a professional team that has an investment mandate to target a certain asset allocation or level of risk. This is because, no matter who we are, we are all susceptible to making terrible behavioural errors when under pressure.

IG Smart Portfolios are designed to assist the investor, both by providing a long-term low-cost allocation that suits your risk profile, but also by removing the temptation to time the markets. Markets fall and markets rise, but to the long-term investor this doesn’t matter. They key is to be rewarded for the risks you take, to harvest the risk premium of different asset classes, and to compound those returns at a steady pace.

You can open an IG Smart Portfolio with as little as £500, and it takes few than 10 minutes to start that investment journey

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●  Discover the benefits of investing your money

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●  Understand how to build a diversified portfolio and manage your risk

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This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.