hen it comes to investing, emotions and money don’t mix. This is easier said than done because our money holds sentimental value – we worked hard for it so now we want to invest it for a better future.
However, making investment decisions based on emotions rarely leads to good outcomes. For example, panic-selling when an investment drops in value can lead to missed returns.
Each year investment analysts at Morningstar publish research comparing the return the average investor makes from investment funds versus the actual performance of the same funds.
The outcome is always the same – the average investor achieves a lower return compared to the fund they invested in. The latest research shows the investor return averaging 7.70 per cent each year over a period of 10 years, while the fund they invested in produced returns of 9.40 per cent each year in the same period.
So what does this mean and why does it happen? It all comes down to investor behaviour – panic selling, for example, or trying to ‘time’ markets, rather than maintaining a disciplined investment approach and leaving the investments as they were for the 10-year period.
With the current state of high inflation, if you are lucky enough to have money to invest this can provide the potential for returns over and above inflation. If you do not need this money for at least five years this is likely a far better use of it than keeping it in cash.
Or maybe you have already started investing? Either way, when it comes to investing make sure you keep a cool head and follow these basic principles.
1. Manage your emotions.
When your investments drop in value it is natural to think you should ‘cut your losses’. However, a market drop is the worst time to sell – it is actually known as ‘wealth destruction’.
Often, doing nothing is the best course of action so that you remain invested to benefit when markets bounce back (which based on evidence, they always do).
2. Let markets work for you.
This is simple – buy it and hold it. The longer you invest, the more likely you are to achieve returns. As Warren Buffet said: “The stock market is a device for transferring money from the impatient to the patient”.
3. Diversify your investments.
Rather than putting all your eggs in one basket, invest in lots of different countries, sectors and industries. This reduces risk and increases exposure to investment opportunities which overall means smoother returns.
4. Don’t try to outguess the market.
It is impossible to consistently outperform the market by attempting to pick ‘winning’ stocks or sectors. Many investors choose stocks which have performed well previously, however this offers little insight into future returns. Vanguard research shows that 29 per cent of top-performing active funds (active meaning actively trying to outperform the market) available to UK investors were in the bottom-performing funds five years later or had been closed or merged with other funds.
Research suggests a simpler approach is better. Spiva investment research shows that investing in a low-cost, globally diverse fund that simply tracks the market, and then leaves it to do its thing, is the best way to proceed. To find a fund that tracks the market, the clue is in the name of the fund. For example, investment funds that track the market typically have ‘index’ in their name, or are known as ‘passive funds’. They can be found when you filter using investment platforms such as AJ Bell, Fidelity, Hargreaves Lansdown.
5. Avoid ‘market timing’.
Unless you have a crystal ball you will never know the perfect time to invest/disinvest – this only becomes clear in hindsight once you have missed it.
One of the biggest costs of ‘market timing’ – moving money in or out of a stock at a set time – is being out of the market when it surges upwards, meaning that you miss out on returns having incorrectly timed the market.
6. Focus on what you can control.
Being a successful investor requires understanding what matters most and drowning out all of the other noise. For example, you cannot change what is happening in the economy or inflation, but you can control your behaviour.
To summarise – when investing, keep costs low, diversify assets and invest for the long term. If you do not feel confident to go it alone, consider working with an independent financial adviser such as myself who can guide you through the maze of different investment vehicles and funds and recommend something suitable for you.
There are plenty of reputable services that can help you search for a financial adviser based on what you’re looking for help with, including Unbiased, Vouchedfor and The Personal Finance Society.
Emma Fielding is a chartered financial planner at First Wealth and contributor to Thrive Money