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Risk Versus Reward

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So far I have given you an understanding of the different tax wrappers within which you can keep your money. I have then given you an idea of how to plan your future financially. However, this Lifetime Cash Flow Forecast will have to make an assumption about the rate at which your money will grow. Even after planning, your money may not grow as you expect. It is now time to understand how you should invest the money once it is inside these wrappers, in order to obtain the growth to meet your Cash Flow Forecast.

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The Eight Investment Mistakes Most People Make

Below are some of the top mistakes that most people make when investing their money.

1. The Inflation Trap

As you know, inflation is the amount by which the real cost of goods goes up each year. The same happens to your money. The first mistake that people make with their investment choices is forgetting to assess their money’s growth in relation to inflation. It is growth over and above inflation that is important, not whether the balance has gone up. As a result, you must keep inflation in mind when assessing your financial progress.

2. Timing The Market

The mistake people make is trying to wait for the markets to change. There is a saying that ‘time in the market’ is better than ‘timing the market’. With the right investment strategy, you may do better to invest, even if markets are falling. Over the long term, even if you happen to have invested at the peak of the market, you will still see the benefits in the returns.

3. Selling With ‘Most People’

When it comes to investing, you don’t want to act like everyone else. When the market is crashing, bankers are telling you to buy tins, and the world is about to end, that is not the time to sell your investments. Most people do, but that it isn’t the time to sell.

4. Active Or Passive Funds

Exchange Traded Funds (ETFs) and Tracker Funds allow you to experience the returns of the whole market, at a very low cost. Because they replicate the whole market, there is no active management and the fees are therefore much lower than actively managed funds. This means you can benefit from decent returns without giving up those returns to high fees.

The biggest mistake people make though is that this is an ‘either/ or’ decision: Either active funds OR passive funds. There are certain markets that are much more difficult to identify a fund that is likely to do well.

5. Property Prices Always Rise

Property prices can fall as well as rise—a heretical viewpoint for some! Before I plough this often difficult furrow, it is worth saying that property should usually form part of a well-diversified portfolio. It is a great asset class because, like shares, property pays you a rent (hopefully) and usually rises in value over time. It does, however, have its problems, some of which are:

– It is relatively illiquid, i.e., you can’t sell it quickly; it might take months, not days.
– It is a physical asset, making it vulnerable; for instance, boilers can go wrong, which costs money.
– Other people are involved, like tenants, who can fail to pay their rent, not move in the day the old tenants move out, or trash your lovely house.
– Most people borrow to purchase property, which dramatically increases the risk of the investment.
– The acquisition costs, like Stamp Duty, lawyers’ fees, searches and possibly mortgage arrangement fees, are high as a percentage of the overall cost.

One key risk that investors overlook is ‘gearing’. Another word for ‘gearing’ is ‘borrowing’. If I said that I want you to borrow £100,000 and invest it into the stock market, most people would rightly say I had lost my marbles. The risk would be off the scale. So why do most people who purchase buy-to-let properties do exactly this? They borrow to invest, which dramatically increases their risk. Even some of the savviest investors miss this key fact.

6. Fund Picking And Past Performance

The next common mistake is that investors pick funds based on past performance. It is easy enough to look at which fund has outperformed another over the last year, and then leap on the bandwagon because it is doing well. Sadly, many who invest through online platforms approach fund picking this way, and they usually see pretty poor performance.

7. Ignoring The Charges And Tax

Tracker funds can play an important role when there is less of a chance of paying a manager to beat the index, because you can get similar returns whilst paying less in charges for the privilege. Charges will always sap some of your returns. Even if you buy and trade your own direct shares, you will have to pay dealing costs and Stamp Duty. As soon as you use a fund, you will pay charges that reduce your returns.

8. The Liquidity Trap

By liquidity risk, I mean how quickly you can get access to your money. Many structured investments involve significant liquidity risk, in that you can’t get your money when you want it.

For many investments that have liquidity risk, you have to consider what returns, if any you can definitely access. So when investing, you need to take account of the dividends that are likely to be paid as well as the capital growth; otherwise, you are missing the boat.

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