Avoiding Ten Common Investing Mistakes
Investors as a whole are good at making mistakes. If you’re relatively new to investing, it’s a good time to make sure you don’t fall into some common traps.
If you have already done a little – or a lot – of investing, you’ll likely recognize some of these mistakes. Understanding that others make them as well may help cushion the blow somewhat. And remember, mistakes happen to us all – the key thing is to learn from them!
Here’s our investors’ Top Ten List Of Mistakes:
Mistake #1: Doing First, Learning Later
Mistake #2: Thinking Short-Term
Mistake #3: Over-estimating Your Talents
Mistake #4: Never Getting Started
Mistake #5: Sticking to One “World-Beating” Sector
Mistake #6: Investing In Companies Because You Like Their Products
Mistake #7: Getting Burned on Hot Stock Tips
Mistake #8: Giving Up When Things Turn Bad
Mistake #9: Not Doing Your Homework
Mistake #10: Not Understanding Risk
Mistake #1: Doing First, Learning Later
Your friends are making money, you’ve been reading the financial pages, watching CNBC, and you’re pumped. What could be more natural than wanting to jump right into investing?
Nothing, but unfortunately nature isn’t always perfect. Your best bet is to educate yourself first. The good news is that with demo and simulator accounts nowadays, you can do both – learn about the markets and satisfy your urge to start investing. A demo account helps you familiarise yourself with investing. The only thing you can’t do… is lose real money!
Mistake #2: Thinking Short-Term
Jumping in and out of the market is a classic mistake made by many investors. The problem is they focus too much on short-term price movements. Real money in the stock market is made over the long haul.
What’s more, if you jump out of a stock just because its dropped slightly for a few days, there’s a good chance you’ll miss out on a swift rise.
In fact, across the stock market as a whole, if you had the bad misfortune to not be invested on a small number of days, you would have lost out on a great deal of the market’s advances. And of course, those days when the market soars can’t be predicted. Stick to your long-term plan, and invest the same way.
Jumping in and out of the market is a classic mistake made by many investors. Test your investing strategies first then apply this learning in the real markets.
Mistake #3: Overestimating Your Talents
Being over-confident about your abilities to consistently beat the stock market and ring up sky-high returns can hurt you.
The more volatile the stocks you trade, the better your chances of racking up some significant returns. If you invested in a bundle of high-flying internet stocks in late 1999, for instance, you could have made five, ten, even twenty times your money!
The problem is, most people who did that didn’t hang onto their profits. Unfortunately, they generally left their money in these volatile stocks and found all their gains – and often some of their original investment – quickly wiped out as the stocks plummeted.
Overestimating your ability to pick winners can lead to poor investing decisions. You may ignore your plan, stop doing research, and forget to think long-term. If you do, that makes you vulnerable to heavy losses if the market changes direction. Many of the same high-tech stocks mentioned above were worth a half to a tenth of their value – by the end of 2000!
Overestimating your ability to pick winners can lead to poor investing decisions. The key to investing is not to time the market, but to maximize your time in the market.
Mistake #4: Never Getting Started
For some, the biggest stock-investing mistake is not investing in stocks.
Often, this is due to a lack of understanding of one basic principle. The longer you can leave your money in the stock market the better the chances are you’ll make money, and conversely, the smaller the chances you’ll lose any of your original investment.
Uncertainty is part of the stock market. When prices are falling, you may be cautious about buying because prices may drop further. And when prices rise, you may feel you’ve missed the boat and things are too pricey. Remember, the key to investing is not to time the market, but to maximize your time in the market.
Mistake #5: Sticking to One “World-Beating” Sector
Technology is changing the world, no doubt. But investors in 1999 and early 2000 began to think that that “dot coms” and other internet companies defied common sense. Even those without any discernible way of making an actual profit often doubled or tripled in a few short months.
But what goes up often comes down with the same speed and severity. By the end of 2000, many of those who had invested all their money in the high-tech sector welcomed in the New Year with negative signs beside their performance numbers for the year.
The lesson to take away here is to diversify your portfolio across a number of sectors and companies, so that you limit the risk of any one of those sectors or companies taking a downturn in the market.
Mistake #6: Investing In Companies Because You Like Their Products
Investing in a company that has products you like is one of the most common investment mistakes. Why? Because emotion rules over common sense.
Consider this example. You’ve bought a new Ford Windstar and you love the look and ride. You think to yourself, “Look at all the people trying to squish two-and-half kids and a dog into a small car. They’ll all be buying Ford Windstars like us.” So you decide to buy Ford’s stock anticipating it will increase in value.
Meanwhile, your neighbors buy Toyota’s minivan, the Sienna. They too like their new vehicle. And they also think Toyota is a good company and decide to buy some Toyota stock.
You can see the problem, can’t you? Which is the better company – Ford or Toyota? That question can’t be answered because neither of the couples had nearly enough information to judge whether both, one, or neither of the stocks were a wise investment or not.
Investing in a company that has products you like is one of the most common investment mistakes.
Mistake #7: Getting Burned on Hot Stock Tips
You probably have somebody in your circle of friends who leaves a trail of tantalizing stock tips in their wake. But whether it’s a family member, a friend or a co-worker, NEVER buy based on a tip. A tip is simply a guess – and often an uninformed one – based on rumor and misinformation.
When stocks soar they hit the headlines and “tips” on that stock start to spread fast and furiously. That’s when knee-jerk investors make the mistake of deciding to get into the action and pick up some shares, driving the price up further.
Here’s where the mistake is made. The reasons for the stock originally soaring have already occurred. What the knee-jerk investors do is artificially drive the share price higher until the market comes to its senses and the stock crashes to earth. And investors who got in late? They’re getting burned on the ride down as they enter the atmosphere.
The trick is to not continue leaping into stocks that are at their peak, and bailing out when they subsequently drop. Invest behind cold, hard facts. Never on rumors or tips.
NEVER buy based on a tip. A tip is simply a guess – and often an uninformed one – based on rumor and misinformation.
Mistake #8: Giving Up When Things Turn Bad
Invest in stocks and you’re bound to have days, weeks, even months where the price of your investments do just one thing – fall. But that’s not necessarily bad. Why? Because stocks never go up in a straight line and if the stock is a sound one, it’s a great opportunity to buy more at lower price.
Some inexperienced investors become depressed whenever their investments decline in value, and they sell. But all that indiscriminate selling does is lock in your losses. Remember that the stock market moves in fits and spurts. If short-term fluctuations in quality investments leave you unnerved – don’t track them. Focus instead on long-term numbers and chances are the gains will be there.
If short-term fluctuations in quality investments leave you unnerved – don’t track them. Focus instead on long-term numbers and chances are the gains will be there.
Mistake #9: Not Doing Your Homework
Many investors will spend more time and energy investigating the right microwave to buy than they will on deciding where to invest their hard-earned dollars.
Researching stocks doesn’t have to be tough or time-consuming. Our Learning Center can show you many simple and powerful strategies for assessing winning stocks.
Nothing in life is for free. If you want to consistently make good long-term returns in the market, you have to put a little effort into research up front.
Many investors will spend more time and energy investigating the right microwave to buy than they will on deciding where to invest their hard-earned dollars.
Mistake #10: Not Understanding Risk
Some people are quite clear. “I don’t like risk” they say. “That ‘s why I stay out of the stock market.”
Unfortunately, not investing in stocks also exposes you to risk – the risk that inflation and taxes will actually eat away at your savings. Even if you manage to keep up with inflation, you may be taking the risk that your money may not grow fast enough without the higher returns generated by stocks to meet your major financial goals in the years ahead.
Understand your risk profile and invest where you are comfortable. But don’t forget the direct relationship between risk and return, and what impact time in the market has on risk.
The higher an investment’s risk, the higher the potential return on that investment. Also, the risk associated with any investment decreases the longer the investment is held.
Key Learning Points
- To make money in the stock market learn first, then invest.
- Short-term volatility is confusing. If you use it to time your investment decisions, you’ll likely lose money. Think long-term.
- Don’t buy a company’s stock simply because you use or like the products. You must look at many factors, including the company’s financial situation, to decide if it’s a good investment.
- Don’t buy stocks on tips, or because they are the flavor of the month. For long-term success, buy a basket of stocks that meet your criteria.
- The stock market falls as well as rises. But over the long haul, the trend is always up. Don’t get discouraged by market set backs. Think of it as prices just taking a breather before they resume their upward climb.
- Stock picking takes a little elbow grease. But the time and effort you put in will reward you with a strong portfolio that allows you to sleep nights and build wealth.
- The stock market is risky but there’s also risk in avoiding the stock market, as your money may not grow fast enough to meet your future needs.
