Flashy ads from banks, financial firms and trading apps can make investing seem like a breeze. Powered by technology, practically anyone can open accounts and purchase financial products with the click of a button from the comfort of their living room.
But trading some stocks is one thing; having sustained, long-term success with your investments is quite another. Successfully achieving your investment goals can have an impressive impact on your financial health, lead to financial independence, allow for early retirement and perhaps even make you very wealthy. On the other hand, accumulating investing mistakes can have devastating effects on your quality of life and your ability to save for retirement.
Here are seven common investing mistakes that beginners (and even experts) often make. Be sure to avoid these investing blunders to set yourself up for financial success.
Investing mistake 1: Not having a game plan
A professional sports team does not go into a championship without a game plan. Likewise, you’ll want to put a long-term financial plan in place before you start investing.
When it comes to investing, always start with savings planning. Your savings plan will outline your investment goals and the time frame for achieving them. You’ll want to make some return assumptions so you know how much to save, while determining your tolerance for investment risk so you can stay on track.
Like all good plans, it is important to revisit them periodically to assess your progress and make any necessary adjustments.
Human emotions are often an investor’s main enemy. If your investment plan is not built on a solid foundation, the emotional highs and lows of investing can confuse even seasoned experts, leading to more mistakes and loss. By having a plan and sticking to it, you take the guesswork out of investing and can sleep soundly – even when things change or markets take a turn.
Investing mistake 2: Trying to time the markets
One of the most well-known characteristics of financial markets is that they work in cycles. They go up, then they go down. History shows us that there are short-term corrections, as well as very long-term cycles.
Market value is determined by the supply and demand of all investors, given the information they have at hand. Consequently, the value of tomorrow’s markets will depend on the information that will only be available tomorrow.
Investors are sometimes pessimistic and sometimes optimistic. Their optimism or pessimism can cloud their judgment, leading them to falsely believe they know what’s going to happen tomorrow. Trying to sell to buy back later or taking huge risks with the hope that they can eventually resell at a better price – in other words, trying to time the market – is one of the most common mistakes investors make. Worse yet, some investors may be right once and mistake luck for knowledge, leading them to make bigger mistakes over and over again.
To succeed in timing the market is a fantasy, and yet many investors fall prey to it – from amateurs to professional traders. According to a study by Investopedia, more than 66% of new traders try to time the market sometimes and 20% try to do it often.
The fact is, investors who try to time the market take on more risk and make less money. Here’s an example. If an investor had missed the top five days of S&P500 returns in the last 20 years (prior to December 31, 2019), his return would have been only 5.62% – about half that of a passive investor. Even worse, if he had missed the best 20 days, the investor’s return would have been negative.
When it comes to the markets, you want to play the long game.As Warren Buffet once said, if you are not willing to hold a stock for 10 years, you should not hold it at all.
Investing mistake 3: Using intuition as an advisor
Humans are emotional creatures. We were designed to use our emotions and intuition to decode and fuel our interpersonal and societal reactions.
When it comes to investments, however, it’s best to keep emotion out of it andrely instead on facts and figures. Indeed, emotions are the source of many bad financial decisions. Greed and fear of missing out (FOMO) on a good investment can lead to unbridled speculation; anxiety and dread can lead to wanting to time the market or selling a good investment after it has shown a short period of good performance.
Your “sixth sense” or a hunch is a bad advisor. Remember, there are always two sides to any transaction: a seller and a buyer. Why does the other investor want to sell the stock you want to buy? Does he have more information than you? Is his decision based on facts? Think of a transaction as a financial battle. Who will win this battle and get rich? The one who knows all the financial data? Or the one who has “a good feeling?”
Investing mistake 4: Lack of diversification
Lack of portfolio diversification is one of the cardinal sins of investing. Poor diversification increases volatility and can be the source of an investor’s worst enemy: the dead loss. Even worse, the concentration risk that results from lack of diversification is a risk that is poorly rewarded by the market.
For example, if you wanted to bet on the evolution of the smartphone 15 years ago, it would have been wiser to hold a portfolio of stocks such as Samsung, Apple, BlackBerry and Nokia in equal parts than to bet everything on BlackBerry or Nokia, which were nonetheless recognized as the world leaders in cell phones at the time.
Or let’s say an investor wanted to bet on the recovery of US bank stock prices, which collapsed in the eye of the storm of the financial crisis in 2008. If they had bet on a portfolio of American banks in an exchange-traded fund, the result would have been fantastic compared to an investor who bet everything on Washington Mutual, which unfortunately went bankrupt.
Lack of diversification can be insidious. It is often seen in the case of employees of public companies who hold shares and options in their employer, as well as shares in their pension fund. At one point in history, a very large number of Nortel employees were millionaires!
So make sure you are adequately diversified, and always think of your portfolio in percentages rather than dollars, as it helps to keep things in perspective.
Investing mistake 5: Gambling instead of investing
There can be a fine line between betting and investing. When managing a portfolio, you bet on certain securities and events. However, the big difference between investment and speculation comes from two factors. First, there’s risk management, which is essential for good investing. That’s why lack of diversification, as I mentioned, is a major mistake, since it introduces a significant risk of loss. Second, “bets” are made by weighing the pros and cons, which are based on facts and real data. We make our bet when the data is calculated, and we can weigh the pros and cons with full knowledge of the facts.
Unfortunately, many investors choose to bet on short-term price fluctuations rather than hold a good company for the long term. Or they bet on a new, exciting technology rather than hold technology stocks that have sales, profitability and cash flow. While these tactics are certainly exhilarating, they’re not the best way to grow your wealth in the long-term. The best kind of investments that are proven to make you money are, well, boring. Nine times out of ten, slow and steady wins the investing race.
Investing mistake 6: Chasing returns
Many investors use recent performance to select their investments. In fact, it is standard practice to classify mutual funds using performance-based star systems.
Unfortunately, when a strategy has been outperforming for a few years, it is probably due for a return to normal.
By trying to invest in funds or strategies that have gone up, you end up selling at the bottom to buy expensive stocks. This is a great strategy to ensure you get anemic returns.
Take Bitcoin, for example. Investors are clamoring to get their hands on crypto, yet most experts recommend caution, as crypto-currencies could easily be another example of an asset bubble about to burst. But the fear of missing out on this dizzying rise and those inflated past returns is a force that is hard to counter in the minds of investors.
Investing mistake 7: Using the wrong information sources
The quality of your information always depends on the source.In finance, misinformation abounds, as unscrupulous people profit by trying to boost the price of certain securities to benefit the sellers.
The many pyramid schemes that have tarnished the history of finance over the years are unfortunate but all-too-common examples.
Because finance is influenced by unknown variables that will take place in the future, it gives way to a cottage industry of financial letters and gurus, who wish to attract the attention of the investor by exploiting his fear and greed with the sole purpose of filling their pockets.
Moreover, even in the absence of malfeasance, there is very often an imbalance of information between the selling party and the buying party in a financial transaction.
Being among those who have incomplete or erroneous information is also a mistake that can have serious consequences. If you recognize yourself in that last sentence, don’t worry! Having wrong or incomplete info is very common, since these errors are caused by human behavioral traits. Thankfully, there’s an easy way to ensure that you have the best information at hand so you can make informed financial decisions.
An experienced, well-equipped and independent financial advisor can be an important ally to help you avoid these common pitfalls, minimize costly mistakes, and maximize your chances of financial success.