Regardless of what you want to achieve from your investments, whether it’s to try to emulate the amazing year-on-year returns of Warren Buffett or more simply to build up a nest egg for retirement, there are mistakes that need to be avoided in order to minimise risks from investing.
Only buying into high-risk shares
I strongly believe it’s vital to minimise the number of stocks in your portfolio that are high-risk. For example, it could be those companies that don’t pay a dividend or those with excessive debts or gearing. I’m a big fan of dividend-paying shares because of the accumulation affects from compound investing over time.
Warren Buffett’s number one rule is to not lose money, and I’d be inclined to listen to him and make sure to not buy only a portfolio of high-risk shares. It’s fine to have some companies that are nascent, but they should only form a small part of a diversified group of holdings.
The trouble at Neil Woodford’s fund that came about as it invested too much in smaller companies – many of which have seen their share prices fall – shows the perils of investing in illiquid, high-risk stocks.
One way to reduce the risk is to invest in smaller companies through an investment fund or investment trust. Granted, it’s less exciting but it should be far more financially rewarding because no one company can have such a large effect on the whole fund or trust – or you, the investor.
Not diversifying enough
Another mistake to avoid is not having enough diversity among your investments. This means geographic diversity and also diversity across a wide range of industries.
Some industries, like house-building, banks, and miners, are cyclical and will rely on the wider economy to perform well. Others, such as consumer staples, pharmaceuticals, and groceries, are defensive, in that consumers will buy the products regardless of what economists say.
There is a balancing act to be aware of with diversification. Holding too many stocks – and the amount which constitutes ‘too many’ is subjective – also could hamper returns.
This is a tricky one, but it’s not always sensible to average down – meaning to buy more shares when the share price has fallen. Sometimes it’s worthwhile and can be profitable if timed right, but there is also the potential for a share that has gone down to fall further.
Whether it is a better move to average up (buy a rising share) is, again, up for debate. But averaging down may well be no better for providing an investor with returns than taking a small loss on an investment that has headed down and moving on.
The fourth investing mistake I think any investor needs to avoid is overlooking the power of dividends. I mentioned this in my first point but let me explain it a little further.
It’s easy to get excited about shares that could offer huge share price gains, sure. And that’s a great thing. But for long-term investors, dividends really do provide a means by which major gains can be made through the power of compound investing – where interest is earned on interest.
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Andy Ross has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.