The inventory market presents a wealth of engaging funding alternatives, from development and dividend shares to funding funds and ETFs. However it’s simple to get caught out by easy errors. A number of premature errors can ship an in any other case worthwhile portfolio spiralling into losses.

Listed below are three key risks to keep away from.

Trusting previous efficiency

Regardless of the outdated adage, there’s actually no assure that historical past will repeat itself. Many metrics depend on previous efficiency with a view to forecast future price motion. In sure eventualities, this may be helpful — notably with shares in cyclical industries.

Nevertheless, there’s a mess of unpredictable components at play, together with environmental geopolitical occasions. Not even probably the most completed forecasters can account for all the pieces.

Resorts, cruises and airways took a battering when Covid hit, regardless of previous efficiency suggesting years of development forward. Main journey group Expedia misplaced half its worth after the pandemic, falling from $17.1bn to $8.1bn.

Defensive shares like AstraZeneca and Unilever may help protect a portfolio from such occasions. They sometimes are likely to proceed performing nicely when the broader market dips.

Making an attempt to catch falling knives

There’s a saying in finance: “By no means attempt to catch a falling knife“. Within the restaurant business, its that means is apparent: you’re going get harm.

In finance, a falling knife is a inventory that’s falling quickly. Typically, such shares recuperate simply as quickly, offering a small window of alternative to seize some low-cost shares.

However generally, they don’t. If the corporate’s on the breaking point, it’ll simply maintain falling. Even a short-term restoration (often known as a ‘dead cat bounce’) is not any assure it’ll maintain going up. This could occur on account of different opportunists attempting to catch knives however failing to avoid wasting the inventory.

By no means purchase a inventory on a whim. Loads of research ought to precede each funding determination. Even when a possibility’s missed, there will probably be many others. 

Blinded by dividends

It’s simple to get sucked in by the promise of excessive dividend returns. Yields may be particularly deceptive, with some shares showing to vow returns of 10% or above. 

It’s essential to keep in mind that a yield will increase if the share price drops whereas the dividend stays the identical. In different phrases, an organization’s inventory might be collapsing, sending its yield hovering. When this occurs, the corporate often cuts the dividend quickly after.

All the time assess whether or not an organization has sufficient free money movement to cowl its dividends. The payout ratio needs to be beneath 80%.

A current instance is Vodafone (LSE: VOD). The yield soared to just about 13% in 2023 all whereas the share price was plummeting. Then earlier this yr, it slashed its dividend in half.

Income slumped nearly 25% in 2023 and earnings per share (EPS) fell to -1p. It now carries quite a lot of debt, which poses a big threat.

However issues are enhancing. Following a restructuring plan, a merger with Three was authorized on the situation of rolling out 5G throughout the UK. Furthermore, the sale of a stake in Indus Towers has helped cowl some debt.

EPS is forecast to succeed in 8p subsequent yr and the common 12-month price goal eyes a 27.4% acquire. If issues proceed, it might absolutely recuperate. However till then, I don’t plan to purchase the shares.