Image source: Getty Images
Investing in a Stocks and Shares ISA can be very rewarding.
But things don’t always work out that way. Indeed, sometimes the value of an ISA may go down rather than up.
Here are three mistakes I’m determined to avoid in my ISA.
1. A very good thing
Five years ago, Nvidia the stock has gone up 2,769%.
That means, if I had invested the entire £20k ISA in the chipmaker in November 2019, I would have had an ISA worth over £570,000.
Hey!
But while it’s easy to look at profit sharing in hindsight, that’s not a luxury open to any investor when making a choice. It was inevitable five years ago that Nvidia would act as aggressively as it did.
If I had put the entire £20k ISA into Nvidia stock five years ago and things didn’t go well, I would have taken an unnecessary risk by not diversifying properly. Nvidia has risen but many other companies that looked promising five years ago have sunk in value.
2. Focusing too much on past performance
When choosing how to invest an ISA, it is common to look at the past performance of shares. That may be when considering wages as part of the price-to-wage ratio for valuation purposes or it may be for profit purposes.
I think that makes sense, as past performance can give an indication of how the business has performed. My preference is to invest in firms with proven business models.
However, past performance, although informative, is not a guide to what may happen in the future. Forgetting this important point can be a costly mistake, for example if it leads to a high-yielding budget investment only to see dividends reduced, or even canceled altogether.
To put this into context, consider Vodafone (LSE: VOD). Back in its 2019-2020 financial year, the company was turning over around €45bn a year and paying dividends of 9c per share. Currently, it has benefited from a strong brand, a large customer base, and a competitive position in a market that looks set to remain large.
Fast forward to today. Revenue is down about 18% and dividends are down by half. The company has been selling assets, which means that revenue is likely to remain lower than before.
Over the past five years, Vodafone’s share price has fallen by 56% and dividends per share have fallen almost as much. In the past five years, previous budget cuts, inconsistent business performance, and a large amount of debt may alert the forward-looking investor to some of the risks, in my opinion.
3. Ignoring benefit cover
A related mistake is looking at dividends without considering the source of the dividends.
When choosing income shares for my ISA, I look at what I expect to happen to free cash flow over the coming years and what that means for profit cover.
Just because a business is going through a weak point doesn’t mean profits are at risk. How well it is covered. If the available free cash flow does not cover (or fails to cover) the cost of the budget as it is, it is a red flag for me as an investor.
Source link
