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A pension is a very important thing, but for much of our working lives (let alone before) we may not give it nearly as much thought as it deserves. Take a Self-Invested Personal Pension (SIPP), for example. Given its long-term nature, it can be tempting when times are busy to put off thinking about it or investing the money in it. But that can be a costly mistake once retirement rolls around.
Here are three mistakes I aim to avoid when investing my own SIPP.
Getting dazzled by the unknown
We know from past experience that the economy will keep evolving. Some shares that are barely known and perhaps even trade for pennies today could turn out to be worth a fortune a decade or two from now.
Sometimes, that fear of missing out leads people to rush into shares they do not understand in case they shoot up in value before they have seized the opportunity.
That is not the sort of prudent, considered investment I want for my SIPP; it is speculation. I try to avoid the mistake of investing in the “next big thing” unless I understand it.
Of course, one’s circle of competence is not static – it is possible to learn about an emerging industry that may sound promising, like renewable energy or biotech.
Failing to diversify
Does this sound like a problem to you? Warren Buffett invested tens of billions of dollars in Apple stock. It did so well that not only did the stock soar in value by tens of billions of dollars, it came to represent by far the largest part of Buffett’s company Berkshire Hathaway’s portfolio of listed shares.
It may not sound like a problem. As billionaire Buffett is still working at 94, his pension may not be a big concern to him.
But Buffett knows what every SIPP investor ought to remember: you can have too much of a good thing.
The tech giant remains Berkshire’s largest shareholding, but share sales mean it no longer dominates the portfolio to the same extent.
Not considering future cash flows
Many investors like the idea of buying dividend shares that can tick over quietly in their SIPP, compounding income for decades. I am one of them.
But it is always important not just to look at the current dividend yield of a share. One must consider the prospective future yield, based on potential future free cash flows.
Take Imperial Brands (LSE: IMB) as an example. Like many tobacco companies, it is a free cash flow machine. In the first half of this year alone, it generated operating cash flows of £1.5bn.
Now, it saw £0.2bn of investing-related cash outflows. It also saw £0.3bn of finance-related cash outflows. But it paid over £1bn of dividends, most of it to shareholders.
If it had not chosen to spend £0.6bn on buying back its own shares, Imperial’s cash flows would comfortably have covered dividends and left money to spare. So far, so good.
Longer term, though, cigarette use is declining. Tobacco volumes fell 3% year on year. The firm has pricing power but in the long term I fear free cash flows could fall and lead to a dividend cut.
I once owned Imperial Brands shares in my SIPP – but no more.
