How to be a better investor

published 26 June 2017

Whether you are a new or seasoned investor, it's a good idea to cast a critical eye over your financial habits. Reflecting on what you do well and where you can improve will encourage you to get into the habit of saving and investing regularly, help you stay calm in times of a market downturn, and make you better at smelling a rat when you're faced with a scam.

First, it's crucial to acknowledge that none of us are as rational as we'd like to think we are. Fifteen years ago, the acclaimed psychologist Daniel Kahneman won the Nobel Prize for Economics for his work with the late Amos Tversky, in which they demonstrated that we are not rational thinkers but emotional creatures when we make financial decisions. Any attempt to make sound financial decisions must take our biases into account and seek ways to get around them.

People find it difficult to give up short-term gratification in order to put their future selves in a better position. One in four UK families has less than £95 in savings, according to a report by insurer Aviva. But saving money becomes easier if we capitalise on our inertia. One of the best ways to get into the habit of saving is by setting up an automatic method that will move your savings into a separate account. This could be money that you automatically deposit from your current account into a savings or investment account once a month after payday.

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Setting up a recurring sum of money to be transferred into your savings can help you adjust your monthly budget and lifestyle in line with your reduced take home pay. For some people having specific goals can be a big motivation, like saving for a car, a holiday, or to cover your children's university fees. Remember to prioritise clearing any existing non-mortgage debt, such as credit-card balances, before you focus on your savings. Debts cost a lot more in interest than savings can earn.

Saving more could also include paying a higher percentage of your pre-tax income into your workplace pension. For younger generations, retirement may seem a lifetime away, but savings made early on in life can go a long way. Research by Which, the consumer advice group, estimates that a person aged 20 needs to put away at least £131 a month to have a comfortable retirement (defined as £18,000 a year to cover essentials such as food, utilities, transport and housing costs). But someone who waits until their 50th birthday to start a pension would need to save almost five times as much (£633 a month) into their workplace pension.

Regular investing takes the advantages of a regular saving habit to the next level. Timing the stockmarket is very difficult. However, stockmarkets have tended to rise in the long run, so those who have put money into the market regularly have usually generated better returns than those who have timed it well. Barclays's annual Equity Gilt Study which analyses how investments have fared over more than a century shows that over a holding period of two years, equities outperform cash in 78 out of 115 years, which equals a 68% likelihood. If one is to hold equities for ten years, the likelihood rises to 91%. So it has historically paid to be a steady, long-term investor.

One sensible approach for investing is to drip feed your money into the market month after month. This way you will benefit from pound-cost averaging, which means that you buy more units of your investments when prices are low and fewer when they are high. Buying in this way can insulate your portfolio from the risks of buying at an unfortunate time (eg, just before a downturn). And by investing regularly over a number of years, you'll benefit from the process of compounding. As ever, being a tortoise is better than being a hare. But of course, once you're invested, it's important to brace yourself for a potential market downturn.

Be under no illusions: you will experience crashes and crisis at some point in your investment career. Those who learn to fight the fear and overcome the temptation to sell their holdings alongside everybody else will do better in the long term than those who succumb to panics. Selling your holdings makes your losses permanent, as it doesn't give markets the chance to recover which a diversified portfolio should eventually do. Indeed, you should be looking to buy, not sell, during panics, as they provide a chance to pick up good investments cheaply.

In short, don't fear volatility, says Russ Mould, investment director at AJ Bell Youinvest, an investment platform. "Volatility is not a measure of risk In fact, volatility can be a chance to buy low and sell high." He points out that some years, such as 2006 or 2016, saw very little market volatility, but there have also been periods of tremendous fear and volatility, in years including 2001-2003 and 2007-2009. These years presented buying opportunities for the brave and cash-rich investors. "The real discipline is to buy then, into the teeth of the declines. The times to be careful and avoid adding risk or even taking some risk off the table are potentially when everything is going up and volatility is very limited and making money looks easy."

As Warren Buffett put it in his latest annual letter to Berkshire Hathaway shareholders: "Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons." While not everybody has the spare billions to deploy that Buffett can call on at such times, investors can make sure they hold back cash to give themselves the opportunity to hunt for bargains when the time comes. Having a well-diversified portfolio across geographies and assets can also help to withstand the danger of having to sell your assets in times of crisis.

People often hear what they like to hear, and believe what they like to believe. So it's important to remember if you're offered something that sounds too good to be true, it probably is. Pension freedoms provide more choice for savers but also new avenues for fraudsters to prey on people's pension savings. For example, in May the Serious Fraud Office launched an investigation into investments in "storage pods", where people were sold storage facilities that were supposed to be rented out in return for income. Unsurprisingly, the promised returns did not materialise and investors were left with assets in random locations that they are unable to sell. More than 1,000 people have potentially been affected by such scams.

Fraudsters often cold call victims, but many have professional-looking websites (as well as prestigious office addresses which are typically virtual or serviced offices). The government had proposed a ban on cold calling, but this has currently been shelved because of the snap general election. Hopefully it will make it into law soon but even if it doesn't, commonsense principles can do a lot to cut the number of people falling prey to pension scams:

Always hang up on cold calls. No legitimate financial firm ever touts for business in this way. And check whether every firm you deal with is regulated by the Financial Conduct Authority (FCA), the UK watchdog, no matter how you got in touch with them. The FCA has an online register, which is a public record of all regulated individuals and firms in financial services, at Register.FCA.org.uk and also keeps a list of well-known scams at ScamSmart.FCA.org.uk.