A Stocks and Shares ISA can be a powerful platform for building wealth over the long term, even from a modest base.
But while rising share prices and dividends could help to create wealth in an ISA, there are also factors that can destroy it.
That is why I try to avoid this trio of common traps when investing.
Getting too excited about one share
Imagine this scenario.
You buy a share you think is brilliant and it goes up a lot. So you buy more – and it goes up further. Excited, you buy even more – and it goes up again.
This is both bad and good, in my view. Clearly the increase in value is good – so what’s bad? The lack of diversification in the ISA.
More and more money being put into one share makes the ISA less diversified. Meanwhile, that share’s rising value means it comes to represent a larger and larger percentage of the overall portfolio.
That can happen to anyone – Warren Buffett’s Apple stake came to dominate his portfolio at one point precisely because the price had risen so far.
Buffett then sold lots of Apple shares, although by hanging on to many he suggested that this was not because he had lost faith in the investment case.
No matter how compelling one share may seem, any smart investor always stays diversified. Even the best companies can run into unexpected business challenges.
Chasing yield regardless of its source
A lot of ISA investors (and I include myself in this) like the passive income potential of a portfolio stuffed with dividend shares.
With a £20k portfolio, the current average FTSE 100 yield of 3.4% would mean annual passive income streams of £680. But a 5% yield would mean £1,000, while a 10% yield would mean £2,000.
The appeal of high yields is easy to understand. It can be addictive.
But as an investor, it is important always to remember that dividends are never guaranteed.
So instead of fixating on a share’s current yield, I try to look at its business prospects and assess what sort of yield I think it may be able to support in future.
Throwing good money after bad
I recently sold all my shares in Boohoo Group (LSE: DEBS). That was a painful decision to make, as not only did I sell for much less than I originally paid, but I also had to consider why I had squandered some of the money in my ISA to buy such a dog.
The reason was that, when I bought, Boohoo had proven its business model, had previously been profitable, was sitting on spare cash and had a strong brand and large user base.
Some of those potential strengths are still true and could help fuel a turnaround. But Boohoo has had an awful few years, losing money hand over fist while battling a downwards sales trend.
Finally I decided to cut my losses. But maybe I should have done that after my first purchase, rather than buying more shares when the price fell.
Badly chosen shares are not the only way one can waste money in an ISA: paying unnecessary fees and charges is another.
So, it pays to pick smartly when using a Stocks and Shares ISA to try to build wealth.
