This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tom Stevenson, investment director for Fidelity Personal Investing shares five of the most common ISA mistakes he’s witnessed.
As the end of the tax year draws nearer, many of us will be looking to make the most of our tax allowances. But as the scramble begins and savers rush to allocate their investments, many will fall foul of mistakes that could harm their portfolio.
Here are five of the most common mistakes and some guidance on how to avoid them.
1. Leaving savings in cash
One of the biggest mistakes made by savers in Britain is leaving a large proportion of their money in cash savings accounts. UK interest rates are at historical lows, and those saving in cash are likely to make real-terms losses on their money, due to the impact of inflation.
Cash vs equities:
If a saver had invested £1,000 in the average high street cash savings account ten years ago, they’d now be left with £1,106.71.
If a saver had invested £1,000 in the FTSE All Share ten years ago, they’d now be left with £2,201.41.
That’s a difference of £1,094.70, despite investing the same amount to begin with.
2. Putting all of your eggs in one basket
While leaving your savings in cash is almost certain to lose you money when accounting for inflation, you’re also exposed to losses if you choose to invest in individual stocks, bonds or other securities. Putting all of your eggs into one investment basket means you’re tied to the fate of one particular asset. You could lose some or even all of your savings overnight by putting all of your money into one stock, whereas investing into a fund gives you exposure to the market while spreading your risk across a range of companies.
3. Making last-minute, lump sum investments, rather than spreading payments through the tax year
What difference does it make when you pay into your ISA, as long as you’re paying in? As it turns out, it makes a lot of difference. Savers are likely to fare much better in the long run if they ‘drip-feed’ money into an ISA, rather than leaving it until the last minute to make a lump sum contribution at the end of the tax year. There are two clear reasons for this.
Compounding – the cumulative effect of saving, where your returns generate returns of their own – can work its magic a lot more powerfully when your money has time to accumulate. The longer your money is held in your ISA, the more it can make for you, so getting in early is important.
Making regular payments means you are less likely to try to time the market. Timing the market is another big mistake made by investors, where attempting to spot the best time to invest can end up costing you. As well as developing a disciplined approach to saving a little each month, making a monthly savings plan means your decisions are diversified throughout business and sentiment cycles.
4. Not doing the proper homework and ignoring your risk threshold
Most of us can think of more exciting ways to spend our time than sifting through investment research to find the best addition to our ISAs. But when it comes to making decisions, it’s important to make the most of the information available – or you could lose out. Luckily, DIY investment tools are now easier to use than ever. There is a range of websites giving information about fund providers and their products.
Linked to the lack of proper homework, there are lots of savers who fail to account for their risk tolerance when planning to invest. Knowing your risk is a personal and individual responsibility – and no two investors are the same.
5. Relying on past performance
When it comes to investing, it’s important to remember that previous performance is not a good guide to future performance. There are plenty of examples of stocks, sectors and indeed fund managers with strong track records and subsequently disappointing performance. One of the main reasons why bonds have been the asset class of choice for the past few years has been investors’ tendency to extrapolate the recent past into the future. By focusing on equity markets’ ‘lost decade’ from 2000, many investors have missed out on the near doubling of the market since the low of 2009.
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