5 common mistakes people make when investing

Tom Bulford examines five common mistakes that private investors make, and explains how you can avoid them.

dissapointed-684

Recently I attended a meeting of a local share club. I enjoyed it. The meeting was held in the pub and the atmosphere was convivial. After two hours of lively discussion, the club decided to sell one share from its small portfolio and add a new one.

From what I know of share clubs, I think that this one was pretty typical. The members were mainly retired gentlemen, who met once a month. They all make regular small contributions to the club's funds, they all take an interest in the stock market and they are clearly intelligent, worldly and successful. And yet their overall investment return has been modest.

Why have they not done better? I detected five mistakes which I believe you should try to avoid.

1: A lack of an overriding strategy

Insofar as the club had any overriding investment strategy, this seemed to be a moving feast. They had tried high yielding blue chips, they had flirted with racier small caps and they had tried to identify some long-term investment themes. But with many different voices around the table and a determination to trade shares on a regular basis, they had never really stuck with anything.

My opinion has always been that investment works best when it is comes from personal conviction based upon research-based knowledge and adherence to a clear investment strategy. I do not think that it matters too much what that investment strategy is. If you are comfortable buying high yielders, then buy high yielders. If you like short-term gambles, then identify these.

Any one single strategy is better than none at all, or than a strategy that changes from one month to the next. But investment by committee will always struggle to find that essential consistency of approach.

2: Making decisions for the sake of them

This club meets once a month. Each time one member is asked to recommend a new share for the portfolio. This is then discussed and unless there is no strong objection it probably gets bought. Warren Buffett once described the stock market as a "no-called strike game". "You don't have to swing at everything", he went on. "You can wait for your pitch."

What this baseball analogy means is that you never have to make investment decisions and you should never do so unless you feel sure that you are making a good one. By forcing yourself to make an investment decision just because it happens to be the date of the monthly meeting or because you happen to have some money burning a hole in your pocket, you are putting the cart before the horse.

3: Lack of understanding of valuation

Valuing shares is a dark art otherwise prices would not be so volatile. But my advice to any investor would be to spend a little time learning about the basics of price/earnings ratios; cash flow; return on capital; debt/equity ratios; stock market capitalisation, etc.

I like to use the analogy of a Rolls-Royce and a Ford Escort. If you were asked which you would prefer, you would naturally opt for the former. But if you were asked to choose between a Rolls-Royce for £1m or a Ford Escort for £100, then you might opt for the latter. Similarly it is one thing to argue that Google is a great business, but is it really worth $156bn? Unless you have some means of relating the strengths and weaknesses of the Google business to its stock market value you will always be a speculator rather than a genuine investor.

4: Poor sources of information

The members of this particular share club seemed to rely mainly upon the Daily Telegraph and the Investors Chronicle. Nothing wrong with these, but by the time news gets reported here it is history so far as share prices are concerned. Rather than relying on old news and second hand opinions investors need to do some primary research. Sites such as FE Investegate, Digital Look (both free) and companies' own websites have a mass of information from which investors can draw their own conclusions.

Of course, if you want specific stock ideas in the small cap arena, then you can get those in my paid newsletter, Red Hot Penny Shares.

5: Determination to take profits

Most successful investors would probably agree that the bulk of their return has come from a handful of really successful companies that they have stuck with over the years. To get these really big returns, you need to stay with these companies and allow them to multiply your invested capital over time. Far too many investors and this seemed to be true of this share club are in too much of a hurry take a profit. This can turn what might ultimately become a really big profit into an immediate, but much smaller one.

Most share club members say that they do it as much for the camaraderie as the profit. But their pleasure would be much enhanced if they made more money. With just a little bit of discipline and work, I am sure that many investment clubs could do so even if they do decide to spend it in the pub.

Note:This is an updated version of an article that was first published in 2011.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by MoneyWeek Ltd.

Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you've bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780.

Recommended

How to invest in ChatGPT and other AI tech changing the world
Tech stocks

How to invest in ChatGPT and other AI tech changing the world

Technology, like ChatGPT, is changing the way we live and work, and this new tool could have a huge impact on the tech industry says Dominic Frisby.
23 Jan 2023
Active investing vs passive investing: which is best?
Investment strategy

Active investing vs passive investing: which is best?

Active investing strategies didn’t do well in 2023 as passive investing continued to draw in new assets.
20 Jan 2023
Key dates for 2023: here are the dates you need to know when it comes to your money
Personal finance

Key dates for 2023: here are the dates you need to know when it comes to your money

There is no shortage of important dates to be aware of this year – which are likely to affect your financial health. We run through the key dates in 2…
4 Jan 2023
Investing trends to watch out for in 2023: what analysts say
Investment strategy

Investing trends to watch out for in 2023: what analysts say

What are sensible strategies for high inflationary times? We ask analysts to find out.
22 Dec 2022

Most Popular

Best savings accounts – February 2023
Savings

Best savings accounts – February 2023

Interest rates on cash savings are making a comeback. We look at the best savings accounts on the market now
3 Feb 2023
The best one-year fixed savings accounts - February 2023
Savings

The best one-year fixed savings accounts - February 2023

Earn almost 5% on one-year fixed savings accounts.
3 Feb 2023
After slumping 42% last year, what's next for Scottish Mortgage?
Investment trusts

After slumping 42% last year, what's next for Scottish Mortgage?

After a spectacular couple of decades, the Scottish Mortgage Investment Trust fell by 42% last year. We take a look at the trust's performance and dis…
3 Feb 2023