10 Ways To Lose Money Without Even Trying

Published in Investing on 29 April 2010

Watch out for these penny pinchers.

There are plenty of obvious ways to lose money when investing in or trading individual shares.

Putting good money into a bad company is the main one! Other big pitfalls include getting scared into selling when your shares fall in price for no real reason, or over-estimating your chances of beating the market.

But even if you avoid these bear traps, there are other -- well -- mousetraps, that are all too easy to get caught out by.

Here are ten that will whittle away your returns, and make the difficult job of outperforming a tracker fund even harder. (And yes, I've done them all at least once!)

1. Watch out for wide spreads

The spread is the difference between the price you pay for a share, and the price you can sell at. It's not at all unusual to find a smallcap with a five to 10% spread, which means that you need the price of your new investment to rise by as much just to break even.

Only invest in a company with a big spread if you're very confident it's undervalued, and preferably you're in for the long term. Try using a Limit Order to buy such shares cheaper than the quoted price.

2. Watch out for a lack of liquidity

Shares that are thinly traded can come with a sting in the tail. The first sign of liquidity is a wide spread. The second is when buying just a few thousand pounds worth moves the price.

Illiquid share prices can jump all over the place, so make sure you know why you're invested and don't be overly worried by short-term movements. Also, don't plan on selling illiquid shares in a bad market -- you're certain to get a terrible deal.

3. Buying the wrong share…

…or too many shares, or too few. Online dealing has made share trading cheap and easy for the masses, but if you're too freewheeling you can slip up when placing your order.

Double check your order is for the right shares -- a fairly easy mistake to make if you're careless is to buy preference shares or bonds in the same company that have a similar stock ticker. Count how many noughts are in your order! And with highly-priced or penny shares, be careful to check you're investing the correct amount.

4. Buying uneconomical parcels of shares

This isn't a slip so much as a bad idea. If it costs you £12.50 to buy and sell your shares, then a round trip is going to cost you £25 in dealing fees. If you invest just £500, then 5% of your money has gone on dealing.

Try to keep such costs limited to 2.5% -- preferably much less. Consider a Sharebuilder service with very purchase low fees (typically £1.50) if you really must buy small quantities of shares.

5. Setting overly tight stop losses

Another strategic error, in my view. I don't like stop losses much in any circumstances, but I really don't see the point in automatically selling shares if they drop by only five or 10%.

Most of the time you'll be selling your shares just because of 'noise' in the markets. Presuming you still like the company, you may end up repurchasing them -- perhaps after they've risen again! Trading fees will quickly mount.

6. Using too much leverage

This one is for any spreadbetters out there. Make sure you understand how the size of your bet 'per point' indicates how much exposure you've got to the shares.

Sensible people who would never think of borrowing £5,000 to buy a share can easily -- and accidentally -- rack up this much effective exposure in their first spreadbet.

7. Paying high fees

Many investors discover trading shares is harder than it looks, and instead turn to trackers, managed funds, or investment trusts.

Nothing wrong with that, but be sure you understand the affect of management fees on your returns.

-- £10,000 invested for 20 years at a 10% return with annual fees of 1% compounds to £23,674.

-- Raise the annual charge to just 1.5%, and you'll end up with over £1,000 less!

8. Dodgily domiciled ETFs

Okay 'dodgy' is a bit strong, but there are certainly differences for UK investors when it comes to where your ETF is registered, due to how the dividends are taxed by overseas and UK authorities.

Read up on any ETF you consider buying. The iShares range is usually the best choice for UK investors from a tax perspective.

9. Getting clobbered by currency swings

Let's say you predict that the German market will boom in the next few years, and you're right -- it rises by 50%. Unfortunately, over the same time period the Euro depreciates by 50% against the pound, too.

Result? Your investment has gone nowhere in Sterling terms. Be sure to take into account how the underlying currency of an investment might perform when venturing overseas.

10. Not using an ISA

Higher-rate taxpayers are throwing money away if they invest outside of an ISA. Lower-rate taxpapers don't pay tax on dividend income, but if your income is in the higher bracket then you pay an effective rate of at least 25% on dividends (more if you're a super-high earner).

True, self-select stocks and shares ISAs usually have an annual charge. But it doesn't take much for the tax savings to cover that cost.

More from Owain Bennallack:

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

nickums 30 Apr 2010 , 5:58pm

Correction: Taxation of dividends in ISAs was introduced a few years back (thanks, Gordon!). But since dividend income for retirees is further taxed another 50% (because the age allowance drops by 50p for every pound of income) , make sure you shelter your hi-div shares in your ISA to avoid this horrible extra taxation..

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