04 Feb 5 common mistakes young investors should avoid
Beginning your investing journey as early in life as possible is vital if you’re to take full advantage of compound interest. Thanks to what Albert Einstein declared the “eighth wonder of the world,” getting into the habit of making even modest monthly contributions can go a long way to building a sizeable nest egg to spend later on.
That said, what you manage to avoid doing as a young investor is just as important. Here are five mistakes that could negatively impact on your chances of growing rich from the stock market.
1. Failing to invest according to your time horizon
Before throwing your money at the market, it’s essential to have some idea of how long you intend to stay invested for. Clearly, those in their 20s and 30s are at a significant advantage over more mature market participants with the former able to greet any downturns with a shrug of the shoulders.
Nevertheless, given the unpredictability of equities over the short term, the stock market is probably not the best destination for your cash if it’s likely you’ll need access to it within only a couple of years in order to, say, pay a deposit on a property.
2. Ignoring the small-cap premium
Thanks to the relative volatility of their share prices, any strategy that involves investing in smaller businesses is traditionally regarded as riskier than buying a selection of companies in the FTSE 100.
However, studies have consistently shown that small companies vastly outperform their larger peers over the long term. Performance over the short term hasn’t been bad either. Last year, the Numis Smaller Companies index (which tracks the bottom tenth of the UK stock market) returned just under 19% compared to the 11% achieved by the FTSE 100.
As such, younger investors should consider keeping at least some of their capital in a diversified group of market minnows.
3. Withdrawing and spending dividends
This one’s simple. Dividends are wonderful to receive but they’re also tempting to spend.
Given that the huge proportion of eventual returns are made from these payouts, the best thing young investors can do is simply re-invest what they receive straight back into the market.
Easy? Perhaps not but the best investors tend to be the most disciplined.
4. Not holding shares inside a tax-efficient account
Since the average retirement age is only heading in one direction, it’s possible that some people in their 20s will want to retain their equity holdings for the next 50 years. The only problem here is that capital gains tax will likely take a sizeable proportion of whatever profits are realised when the time comes to sell.
While we can’t be sure how taxation will change in the future, i’st best to do what you can now to minimise the amount that needs to be given back later. Consider holding all your investments in a stocks and shares ISA or a self-invested personal pension (SIPP). Whatever you make will then be protected.
5. Failing to stay calm
While this could apply to all investors, it’s particularly pertinent to those still young. So long as you’re committed to staying invested for decades, it’s absolutely vital to cultivate the ability to refrain from panicking when others are biting their nails and reaching for the sell button. Your future self will thank you for it.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.