Investing is a tough pursuit, reminding me of fell running. It can often feel like an uphill struggle and a battle in the mind. It’s pretty individualistic and full of uncertainty, and many of us active private investors wish our returns were bigger.
I think avoiding traps such as these ones I’ve identified play a big role in succeeding in the stock market over a long timeframe.
Overtrading
The problem with trading too often is that an investor racks up costs, and unless very skilled, it increases the probability of mistiming the market and individual companies. For most investors, where investing isn’t the only demand on time, trading frequently probably isn’t the best option.
It’s akin to switching careers constantly, how can you ever rise up the ranks and progress if you constantly have to start again? Instead of switching careers, it’s usually better to get the top in a trade or profession by building your knowledge and skills and being promoted. I believe the same thinking should be applied to investing.
It’s better to stick with your investments over a long period of time and keep reinvesting in them than to dip in and out of the market and try to correctly time when a share may go up and down.
Not reinvesting dividends
According to the fund supermarket Hargreaves Lansdown, if you had invested £10,000 in a fund that tracks the broader market of UK companies 20 years ago, it would now be worth £14,666. You would’ve also got back £6,257 in income.
If you didn’t need the income, and chose to reinvest it instead, your total investment pot would’ve more than doubled and grown to £26,096. This example highlights the power of dividends. It shows that, when possible, reinvesting dividends into buying more shares makes a substantial contribution to increasing the overall growth an investor can expect from their investments.
Averaging down
This is where an investor buys a share at a price lower than they originally purchased. A perfect example in my portfolio would be Synthomer. I could buy more now that it has fallen over the last year or so, but all that probably means is I lose more money. Instead, I’m waiting till chemicals companies come back into favour and Synthomer achieves better organic growth.
Rather than averaging down, for many investors, it’s better to hold onto winners and even average up, so buy better performing shares at a slightly higher price, especially if the original case for investing remains intact.
Catching a falling knife
A bit like averaging down, catching a falling knife is a situation where an investor seeks to time the lowest a share will go. This often follows a dramatic fall in a share price, perhaps after a profit warning for example. The difficulty is a share that has fallen dramatically can still fall further. Failures such as Carillion and Interserve exemplify this perfectly.
Catching falling share prices is fraught with difficulties and for most investors, it’s not a viable way to invest in order to become wealthier. Far better to buy quality companies where the share price is rising and there’s a solid investment case.
If you do take a contrarian approach then patience is absolutely key because recoveries and turnarounds in a business can take far longer than expected.
