DIY investing is set to explode off the back of new pension freedoms, but investors need to be aware of potential pitfalls explains Wendy Spires.
DIY investing is widely tipped to explode when the new pension freedoms kick in, allowing retirees to invest (or indeed spend) their savings pots as they wish rather than purchase an annuity. And of course, DIY investing has already been rising in popularity for some years now, in line with the proliferation of online investment platforms which have made trading and easier – and cheaper – than ever.
DIY investors today can build a portfolio with a few clicks of the mouse (or, to put it more accurately, have an algorithm construct one for them). But while today’s investment platforms can help investors avoid some of the more basic investment errors, it’s often said that these can give users a false sense of security. What DIY investment platforms don’t tend to highlight is just how difficult it can be to make respectable investment returns consistently over the long term.
The long-term implications of the incoming pension freedoms are being hotly-debated. While it is (hopefully) erroneous to suggest that Ferrari orders are set to rocket, concerns that many individuals’ pots will be depleted ahead of time, as it were, do seem valid. Many people will want to enter some kind of drawdown, but investing the remaining funds in such a way that they provide the right mixture of income and gains, and at an acceptable level of risk, is no easy task for the layperson. Factor in an unknown investment time horizon – which may nevertheless stretch to several decades after retirement – and it is easy to see why so many industry commentators are expressing worries.
The “death of annuities” has therefore thrown some of the real “health warnings” around DIY investing into stark relief. The following “DIY Don’ts” apply to all investors, but – given the importance of pension pots to maintaining a desirable standard of living – retirees should pay particular heed.
- Under-appreciating risk (and the need for it)
Really understanding investment risk and one’s tolerance for it – both psychologically and pragmatically – is the bedrock of a successful DIY investment strategy. It is easy to accept that all investments carry some degree of risk (even cash deposits, hence the need for the Financial Services Compensation Scheme) or they would not offer a return at all. What can be harder to see is all the different risks which may assail your portfolio and jeopardise your financial plans.
Inadequate diversification (see below) increases the likelihood that all your investments will fall in value at the same time, but this is just one type of risk to look out for. You need to view your current investments (and any prospective ones) through the lens of geopolitical risks, economic developments, currency movements, sectoral trends and so on simultaneously to try to minimise shocks to your portfolio and maximise profits. Balancing the risk/return profile of all your investments to suit your aims is the goal.
A keen eye on risk is essential, but also bear in mind that you may need to take on a little more investment risk than you might first assume in order to achieve your financial goals in the timeframe you wish. It can be helpful to think about different investment pots, each with a slightly different risk profile set according to its purpose. This approach is often deployed by professional portfolio managers.
- Inadequate investment diversification
Paying insufficient attention to diversification – across asset classes, geographical regions, sectors and indeed individual investment vehicles – is incredibly common among DIY-ers and is a real source of investment risk
Some rules around diversification are simple to follow, such as the accepted wisdom that fund investors should limit their allocation to a single vehicle to 10% or less of their total portfolio. But proper diversification runs much deeper than this and it is all too easy to unwittingly fall into being seriously over-exposed to one sector or market. This is could easily the case with property, with investors going down the buy-to-let route, while simultaneously investing in a Real Estate Investment Trust and house-building companies, for example.
However, there is such a thing as over diversification too and you should avoid creating a portfolio that is difficult to monitor and unwieldy to manage. You may well get a lot of out discussing your existing investments over with an investment adviser to check if your portfolio is sufficiently diversified (and streamlined) for your needs.
- Neglecting tax wrappers
It is essential that all investors make use of tax wrappers like ISAs to hold their investments, so that they will not be liable for Capital Gains Tax on capital growth or any more income tax. Individual equities, collective funds and government and corporate bonds can all be held within ISAs, and investors can now put £15,000 a year into these accounts. Too often, however, investors make the mistake of pouring all their allowance in as a lump sum the end of the tax year.
This is a mistake on two counts. Firstly, you must always be encouraging compounding to do its magic and that means putting your money into your ISA as soon as possible. Secondly, by drip-feeding your investments you make it easier to follow a disciplined investment approach rather than getting sucked into trying to time the markets and making expensive investment mistakes as a result.
Currently, around three-quarters of the investors who come to findaWEALTHMANAGER.com are seeking a discretionary relationship where they can hand over responsibility for the management and administration of their portfolio. Scheduling investments to take full advantage of tax wrappers is standard procedure for professional wealth managers, and it should be for DIY investors too. In fact, timing your investments – and the realisation of any gains – so that tax liabilities are minimised might make all the difference to the growth of your wealth. There are a number of clever strategies for this which the DIY investor might miss.
DIY investing can be very rewarding for those able to take a disciplined approach and attend to a number of different considerations all at the same time. Diversification, risk management and maximising tax wrappers are just a few of the top-level tips to bear in mind, yet they all point to one of the most important factors of all: discipline. As those who have fallen prey to “DIY Don’ts” will attest, maintaining the discipline to invest rationally, strategically and systematically can actually be a lot harder than it initially seems. Often, the ultimate act of investment discipline is acknowledging the need for some help and advice.
If you are unsure about DIY investing and would like to explore what a professional could bring to the table, try our smart online tool. Or, if you would like to discuss your situation with our straight-talking team, please do get in touch here.