In the below article, a team of experts put under the spotlight an array of cardinal sins that are committed far too often during ISA season.
Buying into recent successes
Apollo’s Ryan Hughes (pictured) believes it is a big mistake to simply buy what has done well recently.
He said: “Too many times in my career I have seen investors simply pile their ISA allowance into asset classes, regions and funds that have had a sparkling preceding 12 months with little thought about the market and the economy going forwards.”
“All too often, this ends with a sharp dose of mean reversion when these funds tumble to the bottom of the performance charts. A great lesson I was taught early in my career is that you need to be an investor not a collector, with every investment decision you make needing to be done in the context of your overall portfolio rather than in isolation. This is as true now as it was then and anyone making investment decisions this ISA season needs to bear this in mind.”
Not reinvesting your dividends
AXA Wealth head of investing Adrian Lowcock believes the worst sin of all is not using your ISA, arguing that investing is critical if you can afford it. However, secondary to this he believes that not reinvesting your dividends is a huge mistake.
He said: “Reinvesting dividends and earning income from the reinvested dividends is one of the most reliable long-term investment strategies. It will not deliver high returns in the short term but it is powerful over the longer term. This is known as compound interest and was described by Einstein as the ‘Eighth Wonder of the World’.”
According to Lowcock, the FTSE All Share returned 50 per cent over the past 10 years to the end of February without reinvested dividends. With dividends reinvested, it returned more than 110 per cent.
Performance of FTSE All Share with and without reinvested dividends
Source: FE Analytics
“Dividends continue to be under-appreciated by investors,” he added. “Companies which focus on producing a dividend are frequently well-managed, have good cash flow and are more shareholder-friendly.”
Following the crowd
Whitechurch Securities head of research Ben Willis (pictured) believes investors need to do their own investigations into potential investments, rather than picking what’s popular.
“Don’t follow the herd and pick ‘flavour of the month’ funds,” he said. “For example, biotech has had a phenomenal run over the last year but don’t just buy the sector on the back of that.”
Willis says it is important for investors to get under a fund’s bonnet and find out what companies it is investing in.
He said: “If you are looking at where to invest, don’t just base it on the popularity and short-term performance of a sector or asset class that has performed very well.”
Not rebalancing
Patrick Connolly, head of communications at Chase de Vere, thinks it’s vital to keep an eye on the shape of your portfolio. Otherwise, you could end up inadvertently taking either too much or too little exposure to some areas.
He said: “To ensure that this doesn’t happen, you should look to rebalance regularly. This involves selling some of your investments which have performed well and now represent a larger proportion of your portfolio, and reinvesting into those which have performed poorly and are now a smaller amount of your portfolio.”
“This will help to get you back to your starting position and so control the amount of risk you’re taking.”
When re-balancing, Connolly stresses it’s also important to diversify risks by investing in a range of asset classes that don’t rise and fall together.
Forgetting to review previous performance
Frazer Wilson, senior consultant at Thomas Miller Investment, said: “Many investors are more interested in when their next annual allowance is paid rather than regularly reviewing the performance of their previous decisions, be that cash or investment-orientated.”
Wilson warns that it is easy to become distracted by choosing new investment areas rather than looking back at your old investment areas and seeing how well they worked.
He added: “With many people now having accumulated significant sums within ISA wrappers, this review is likely to reap better rewards than trying to pick where the next best investment area is for their annual allowance.”
Ignoring volatility
Meera Hearnden, senior investment manager at Parmenion, urges investors to consider their risk tolerance before making any big ISA decisions.
She said: “It is easy to look at past performance figures and base investment decisions on what has done well in the last year or so. However, this performance could have come at a high cost of volatility.”
Hearnden therefore believes that performance and volatility should go hand in hand when choosing an investment.
She explained: “If you look at the emerging markets sector for example, the range of volatility from the least volatile fund to the most volatile fund is significant.”
“Not only is this a high risk sector but the least volatile fund over one year is the Templeton Emerging Markets Smaller Companies while the most volatile fund is the Lazard Emerging Markets.”
“You would expect the Lazard fund to have delivered a better return, but in fact, the Templeton fund has performed better delivering a return for less than half the volatility.”
Funds over five years compared with sector
Source: FE Analytics
Getting caught up in ISA season hype
Martin Bamford, chartered financial planner and managing director at Informed Choice, believes the biggest sin is waiting until the end of the tax year before using your ISA allowance.
“This wastes a whole year of tax-free investment growth,” he said, “which, compounded over time, can result in a big loss.”
“It also means the investor is more likely to get caught up in the hype of ‘ISA season’ and invest in inappropriate funds, taking too much or too little risk with their money.”
Instead, Bamford believes it is better to invest at the start of the tax year, based on individual financial planning objectives, and drip feed in over the next 12 months.
He said: “Doing this also helps lower the blood pressure of your stressed financial adviser who finds the end of the tax year a perennial misery due to last-minute ISA and pension contributions.”
Following stock market ‘truisms’
Maike Currie (pictured), associate investment director at Fidelity Personal Investing, warns that most market adages, especially those based on the time of the year, should be treated with caution.
“Sometimes they work and sometimes they don’t,” she said. “It’s very difficult to predict the best time to be in and out of the market, especially as the best and worst days very often tend to bunch together during periods of heightened volatility.”
Currie says it’s a common mistake to capture the worst days while missing out on the best days. What’s more, it’s common knowledge that it is impossible to consistently predict everything the market is going to do correctly.
She added: “Remember: time in the market matters more than timing the market.”
Assumption
Tony Müdd, divisional director of tax and consultancy at St. James’s Place, believes that people become overly comfortable with how they choose to invest.
He said: “The assumption that changes to the taxation of other or alternate tax wrappers will have no bearing on whether an ISA even remains the investment of choice. Changes to the rules around access to pensions, for those 55 or over, now makes pensions more attractive than an ISA, on a straight comparative basis.”
According to Müdd’s calculations, pensions have a 6.25 per cent uplift compared to an ISA.