Investing can be intricate, but there are fundamental principles that can guide you, no matter if you’re starting with £1,000 or £1 million. Here are six key behaviors that can help you succeed in the long run.
1: Understand the Trade-off Between Risk and Return
Recognizing the relationship between risk and return is vital when investing.
Different investment types carry varying levels of risk. For instance, equities are generally considered riskier than bonds, and investments in emerging market equities usually entail even higher risks than developed market equities. Typically, a higher risk level offers the potential for greater returns, but there is also the possibility of declines in value.
It’s essential to identify and maintain a risk level that you find comfortable. This approach can lead to a more consistent investment experience. Opting for a high-risk strategy to chase higher returns but then losing sleep over potential losses is not a recipe for success. Your investment style should align with your comfort level.
Keep in mind that your risk tolerance might shift throughout different phases of your life. For instance, as you approach retirement, your focus might pivot to preserving wealth rather than accumulating it. A good investment provider should allow you to review and adjust your risk profile (you can learn how to do this with a Nutmeg account here), but it’s crucial to invest within a risk level that brings you peace of mind.
Unlike savings accounts, investment portfolios are subject to market fluctuations. Volatility—a natural aspect of the investing process—requires patience and a long-term outlook. Although risk and volatility are distinct concepts, they are closely linked. Your chosen risk level will likely influence the degree of volatility you experience in your portfolio over time.
2: Embrace Diversification
The saying “don’t put all your eggs in one basket” has endured in investment discussions for a reason. The concept is straightforward: if you’re going to invest, spread your risk across a variety of companies and asset classes. This strategy reduces exposure to any single company, sector, or asset class that could negatively impact your returns.
Diversification is often referred to as “the only free lunch in investing” for good reason. By investing across different asset types, you can help mitigate risk and enhance your chances for greater returns.
A well-diversified portfolio benefits from assets that have low correlation with one another. If, for example, you invest solely in the technology sector and that sector suffers due to regulatory changes, your entire investment could be at significant risk.
3: Invest for the Long-Term
Frequently jumping in and out of the market can lead to missed opportunities. Investing should always be approached as a long-term endeavor—we recommend a minimum horizon of three years. Emotional reactions to sudden losses or volatile markets can tempt investors to make impulsive decisions. While no one enjoys seeing their portfolio decrease in value, maintaining composure can yield favorable results over time.
Historical data on global developed market stocks from the past 50 years shows that the likelihood of incurring losses decreases the longer you stay invested. The chart below illustrates how long-term investing can significantly reduce loss probabilities.
Chart: The probability of loss decreases with longer equity holding periods (1972 – 2023)
Source: Macrobond; MSCI World Equity Mid and MSCI Large Cap Total Return in GBP, January 3, 1972 – March 2023
4: Rebalance Regularly
Rebalancing is a critical part of investment management that keeps your portfolio aligned with its objectives and risk profile. This process involves adjusting the proportions of assets within your portfolio to maintain its intended allocation.
As market conditions fluctuate, the value of individual holdings within your portfolio can change, altering their overall weight.
If your portfolio’s allocations drift from their original proportions, the risk exposure will also shift. Since higher-returning assets often carry more risk, over time, your allocation to these investments may grow, increasing your overall risk level.
At Nutmeg, our investment team actively monitors your portfolio and rebalances it regularly to ensure alignment with your chosen risk profile.
5: Keep Costs in Line with Your Investment Approach
Investment products can generally be categorized as ‘active’ or ‘passive.’ Active funds aim to outperform the market, typically through individual fund managers making stock selections. In contrast, passive funds (like the ETFs utilized by Nutmeg) focus on delivering market returns. Historical data indicates that finding an active manager who consistently beats the market is less likely than finding one who underperforms.
Moreover, active funds usually come with significantly higher fees, which can eat into your returns. According to Morningstar, the average fee for an active stock-picking fund was 1.03% as of December 2021, while passive funds averaged just 0.55%. At Nutmeg, we prioritize keeping costs low by utilizing passive exchange-traded funds.
6: Maximize Your Tax-Free Allowances: ISAs, Pensions, and More
Each tax year, the government offers a set of annual allowances that facilitate tax-efficient investing. By taking full advantage of your ISA allowance and reviewing your pension contributions, you can effectively build a portfolio of tax-efficient investments. If you’d like personalized guidance on how to maximize your savings and investments, consider booking a free consultation with one of our experts.
Risk Warning
As with all investments, your capital is at risk. The value of your Nutmeg portfolio may fluctuate, and you might receive less than your original investment. Past performance is not a reliable indicator of future results. Tax treatment depends on your individual circumstances and may change in the future.
Let me know if you need any further adjustments or additional information!