A SIPP can be a powerful way to build wealth ahead of retirement. But whether it turns out that way depends, in part, on what you do with it along the way.
Here are three potentially (very) expensive mistakes that can reduce, or even destroy, the long-term value of a SIPP. I am trying to avoid them all!
1. Putting too many eggs in one basket
It sounds obvious, but so do many mistakes in retrospect: putting too much (let alone all) of a SIPP in one share is an unnecessarily risky move.
On paper, diversification seems sensible enough. In practice, it can be hard even for very smart investors, for a couple of understandable reasons.
Sometimes, one idea seems so much stronger than any other ones. Why put money into your second-best idea if your top idea seems far better?
Even if you do diversify, what happens when one stock does brilliantly?
Imagine I had spread my SIPP evenly over five shares five years ago. Four went nowhere, but the fifth was Nvidia. It has surged 2,706% during that period. Nvidia would now represent 89% of my SIPP. Ought I to sell some or all of a holding purely because it has performed spectacularly?
In such thinking lie the seeds of unnecessary risk. Diversification is always an important risk management tool.
2. Getting sucked into value traps
A SIPP is a long-term investment vehicle. In that sense, it can cast a brutal light on the difference between a share that is having a good run and one whose performance is tied to brilliant underlying business performance.
Getting sucked into a value trap can be a costly mistake for any investor. Over time, quality outs — and a SIPP can be a decades-long investment project.
This mistake could incur me a sizeable paper loss. I may compound that problem by hanging onto a dog hoping it can get back to its former price, meaning I also have an opportunity cost of not putting my money to work in much better investment ideas.
3. Ignoring total return
I have a number of high-yield income shares in my SIPP and I do not see that changing any time soon.
But both income and growth contribute to a share’s total return, for better or for worse. Fixating on getting the right yield for my SIPP could lead me to sacrifice overall return.
Consider PIMCO High Income Fund (NYSE PHK). The share does what it says on the tin, offering a juicy dividend — paid monthly.
More specifically, the fund “seeks high current income, with capital appreciation as a secondary objective”.
Indeed, capital appreciation is clearly not the main objective.
The share has lost 38% in the past five years. The dividend yield is around 12%, which means that from an income perspective it is lucrative.
Looked at in terms of total return, though, that income has been significantly mitigated by a decline in share price. Over time, the fund has repeatedly cut its dividend per share, in turn pushing the share price down.
I like income as much as any investor – but I aim to own shares in my SIPP that can generate income and hopefully capital growth too.
