One of the most challenging aspects of investing is being able to control your emotions. That’s because by our very nature we are wired to listen to how we feel about a decision, rather than whether it is a logical one or not. And while gut feeling and listening to our emotions can help in a wide range of situations in life, investing is unfortunately not one of them.
For example, many investors become overly fearful when stock markets are low. That’s because they are often in loss-making territory and so fear kicks in. This tells them to reduce risk and stay out of the stock market, which may seem like a reasonable assumption to make since the stock market has lost them money. However, it is during such downturns when profits are made and while it can take time for shares to recover, history shows us that they always have.
Similarly, becoming complacent and overly confident during bull markets can reduce investment returns. Many investors end up buying during such periods since the outlook is relatively positive for the stock market. However, much of this is often reflected in share prices and this means that there is only a sliver of a margin of safety on offer. Therefore, if the future turns out to be even slightly disappointing, investment returns may be negative.
Clearly, ignoring emotions when making investment-related decisions is difficult, but by focusing on facts and figures rather than fear and greed, your investment returns could be much higher.
Similarly, paying less tax from investment gains is another way to improve investment returns. While the amount of tax paid in the short run may be relatively small, over a long period it can really add up, so using tax efficient means of investing such as ISAs and SIPPs makes sense.
For example, investing through an ISA means that no capital gains tax is paid on profits, while dividends received are not counted towards an individual’s taxable income. And with no income tax being payable on SIPP and pension contributions, they should amass higher returns over the long run than a bog-standard sharedealing account.
As well as ignoring emotions and investing tax efficiently, focusing on dividends could be a wise move for long term investors. That’s partly because a large proportion of total investment returns over the long run are generated from income, but also because dividends provide an indication of the financial health of a business.
Certainly, start-ups and fast-growing companies are unlikely to pay high dividends, but for many businesses it is a good indicator of their overall financial health. And with a rising dividend indicating management’s confidence in the long term prospects for a company, they could provide an indication of the future performance of the business. Moreover, with interest rates set to remain low over the coming years, the FTSE 100’s 4% yield could prove to be highly appealing for the majority of investors.