What Not to Do When Investing
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When learning how to invest, it is important to learn from the best, and to avoid these 22 common investing mistakes.
Reacting to the Media Happenings
There are many 24-hour news channels that make money by showing “tradable” information.
It would be foolish to try to keep up. The key is to parse valuable information out of all the noise.
Successful and seasoned investors gather information from several independent sources and conduct their own research and analysis.
Using the news as a main source of investment analysis is a common investor mistake. By the time the information has become public, it has already been factored into market pricing.
A high-yielding asset is a very seductive thing. Why wouldn’t you try to maximize the amount of money you get back?
Simple: Past returns are no indication of future performance and the highest yields always carry the highest risks. Focus and don’t get distracted while disregarding risk management.
Trying to Time the Market
Market timing is possible, but very hard. For untrained investors, trying to make a well-timed call can be their undoing.
Investors are better off contributing consistently to their investment portfolio rather than trying to trade in and out in an attempt to time the market.
Attempting to time the market also kills returns. Successfully timing the market is extremely difficult. Even institutional investors often fail to do it successfully.
On average, nearly 94% of the variation of returns over time was explained by the investment policy decision.
Lack of due diligence
You can check whether the people managing your money have the training, experience, and ethical standing to merit your trust.
Why wouldn’t you check them? Ask for references and check their work on the investments that they recommend.
Any investor should not invest in companies whose business models you don't understand.
The best way to avoid this is to build a diversified portfolio of exchange traded funds (ETFs) or mutual funds.
If you do invest in individual stocks, make sure you thoroughly understand each company those stocks represent before you invest.
Working with the Wrong Investment Adviser
An investment adviser should be your partner in achieving your investment goals.
The ideal financial professional and service provider not only has the ability to solve your problems but shares a similar philosophy about investing.
The benefits of taking extra time to find the right adviser far outweigh the comfort of making a quick investment decision.
Letting emotions get in the way
Investing brings up significant emotional issues that can impede your decision making.
A good financial adviser will be able to help you construct a plan that works. Investors should not let fear or greed control their decisions.
Stock market returns may deviate wildly over a shorter time frame, but, over the long term, historical returns tend to favor patient investors.
Forgetting about inflation
Most investors focus on nominal returns instead of real returns. This means looking at and comparing performance after fees and inflation.
Even if the economy is not in a massive inflation, some costs will still rise.
It is important to remember that what you can buy with the assets you have is in many ways more important than their value.
Develop a discipline of focusing on what is really important: your returns after adjusting for rising costs.
Neglecting to Start or Continue Investing
Most investors often fail to begin an investment program simply because they lack basic knowledge of where or how to start.
Periods of inactivity are frequently the result of lethargy or discouragement over previous investment losses. Investment management is a discipline that is not complicated, but requires continual effort and analysis in order to be successful.
Not Having Control
You can’t control what the market will bear, but you can save more money. Continuously investing capital over time can have as much influence on wealth accumulation as the return on investment.
This is the surest way to increase the probability of reaching your financial goals.
Investing for the long term involves creating a well-diversified portfolio to provide you with the appropriate levels of risk and return. But no one can predict or control what returns the market will actually provide.
It is important not to expect too much. No one can tell you what a reasonable rate of return is without having an understanding of your goals, and your current asset allocation.
No Clear Investment Goals
Many investors focus on the latest investment trends or on maximizing short-term investment returns instead of creating an investment portfolio that has a high probability of achieving their long-term investment objectives.
Investment plans, strategies, the portfolio, and even individual securities can be configured with your life objectives in mind.
The best way to create a portfolio that has the potential to provide appropriate levels of risk and return in various market scenarios is by having enough diversification.
Too much diversification and too many exposures can also affect performance. The best course of action is to find a balance.
While professional investors may be able to generate excess return over a benchmark by investing in a few concentrated positions, common investors should not try this. It is wise to consider diversification.
When building an exchange traded fund (ETF) or mutual fund portfolio, it's important to allocate exposure to all major sectors.
For an individual stock portfolio, include all major sectors. Do not allocate more than 5% to 10% to any single investment.
Lack of Focus on Performance
If you are a long-term investor, speculating on performance in the short term can be a recipe for
disaster because it can make you second guess your strategy and motivate short-term portfolio modifications.
Look past short term gains to the factors that drive long-term performance and if you find yourself looking short term, refocus.
Buying High and Selling Low
The fundamental principle of investing is to buy low and sell high. Many investment decisions are motivated by fear or greed.
Most investors buy high in an attempt to maximize short-term returns instead of trying to achieve long-term investment goals.
A focus on short-term returns leads to investing in the latest investment craze or investing in the assets or investment strategies that were effective in the past.
Once an investment has become popular, it becomes more difficult to have an edge in determining its true value.
Too much Trading
When investing, patience is a virtue. It takes time to gain the ultimate benefits of an investment and asset allocation strategy.
Continuous modification of investment tactics and portfolio composition can reduce returns through greater transaction fees, and can also result in taking unanticipated and uncompensated risks.
You should always be sure you are on track. A slow and steady approach to portfolio growth will yield greater returns in the long run.
Expecting a portfolio to do something other than what it is designed to do is a recipe for disaster. You need to keep your expectations realistic with regard to the timeline for portfolio growth and investment returns.
Paying Excessive Fees and Commissions
Investing in a high-cost fund or paying too much in advisory fees is a common mistake. Even a small increase in fees can have a significant effect on wealth over the long term.
Before you open an investment account, be aware of the potential cost of every investment decision. Look for funds that have fees that make sense and make sure you are receiving value for the fees you are paying.
Too much Focus on Taxes
Making investment decisions on the basis of potential tax consequences is still a common investor mistake. You should be smart about taxes.
Tax loss harvesting can improve your returns significantly but it is important that the drive to buy or sell a security is driven by its merits, not the tax consequences.
Not reviewing investments regularly
If you are invested in a diversified portfolio, there is a chance that some things will go up while others go down.
At the end of a quarter or a year, the portfolio you built with careful planning will start to look quite different.
Check in regularly (maybe a minimum once a year) to make sure that your investments still make sense for your situation and that your portfolio doesn’t need rebalancing.
Investing in the Wrong Type of Risk
Investing involves taking some level of risk in exchange for potential reward. Taking too much risk can lead to large variations in investment performance. Taking less risk can result in returns too low to achieve your financial goals.
Make sure that you know your financial and ability to take risks and recognize the investment risks you are taking. Turnover, or jumping in and out of positions, is another return killer.
Unless you're an institutional investor with the benefit of low commission rates, the transaction costs can negatively affect your investments.
Lack of Knowledge on the True Performance of Your Investments
Many people have no idea how their investments have performed. Even if they know the headline result or how a couple of their stocks have done, they rarely know how they have performed in the context of their portfolio.
You have to relate the performance of your overall portfolio to your plan to see if you are on track after accounting for costs and inflation.
Waiting to Get Even
Getting even is just another way to ensure you lose any profit you might have accumulated. It means that you are waiting to sell a loser until it gets back to its original cost basis.
By failing to realize a loss, investors are actually losing in two ways. They avoid selling a loser, which may continue to slide until it's worthless. Second, there's the opportunity cost of the better use of your invested money.
Falling in Love With a Company
When we see a company we've invested in do well, it's easy to fall in love with it and forget that we bought the stock as an investment.
Always remember, you bought this stock to make money. If any of the fundamentals that drove you to buy into the company change, consider selling the stock.
How to Avoid These Investing Mistakes
An investor ruled by emotion may see negative returns and panic sell, when in fact they probably would have been better off holding the investment for the long term. Patient investors may benefit from the irrational decisions of other investors.
Mistakes are part of the investing process. Knowing what they are, when you're committing them, and how to avoid them will help you succeed as an investor.
To avoid committing common investing mistakes, develop a thoughtful, systematic plan, and stick with it. If you must do something risky, set aside some money that you are fully prepared to lose.
Follow these guidelines, and you will be well on your way to building a portfolio that will provide many happy returns over the long term.
Develop a Plan of Action
Proactively determine where you are in the investment life cycle, what your goals are, and how much you need to invest to get there. If you don't feel qualified to do this, seek a reputable financial planner.
Also, remember why you are investing your money, and you will be inspired to save more and may find it easier to determine the right allocation for your portfolio.
Temper your expectations to historical market returns. Do not expect your portfolio to make you rich overnight.
A consistent, long-term investment strategy over time is what will build wealth. Before you make any investment decision, sit down and take an honest look at your entire financial situation.
The first step to successful investing is figuring out your goals and risk tolerance. There is no guarantee that you’ll make money from your investments.
But if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the long-term and enjoy the benefits of managing your money.
Put your Plan on Automatic
As your income grows, you may want to add more. Monitor your investments. At the end of every year, review your investments and their performance.
Determine whether your equity-to-fixed-income ratio should stay the same or change based on where you are in life.
Allocate some money aside you can afford to lose
We all get tempted by the need to spend money at times. Instead of trying to fight it, go with it. Set aside investment money.
You should limit this amount to no more than 5% of your investment portfolio, and it should be money that you can afford to lose.
Do not use your retirement money. Always seek investments from a reputable financial firm. Because this process is like gambling, follow the same rules. Limit your losses to your principal (do not sell calls on stocks you don't own).
Be prepared to lose 100% of your investment and choose and stick to a predetermined limit to determine when you will walk away.
Evaluate your Risk Comfort Zone.
All investments involve some degree of risk. If you intend to buy securities like stocks, bonds, or mutual funds, it's important that you understand that you could lose some or all of your money before you invest.
The money you invest in securities is not federally insured. You could lose your principal. That’s true even if you buy your investments through a bank.The reward for taking on risk is the potential for a greater investment return.
If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents.
On the other hand, investing solely in cash investments may be appropriate for short-term financial goals.
The principal concern for those investing in cash equivalents is inflation risk, which is the risk that inflation will outpace and erode returns over time.
Consider Diversifying Your Investments.
By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can help protect against significant losses.
Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns.
By investing in more than one asset category, you'll reduce the risk that you'll lose money and your portfolio's overall investment returns will have a smooth ride.
If one asset category's investment return falls, you'll be in a position to counteract your losses in that asset category with better investment returns in another asset category.
Asset allocation is also important because if you don't include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal.
Be careful if investing heavily in shares of employer’s stock or any individual stock.
You’ll be exposed to significant investment risk if you invest heavily in shares of your employer’s stock or any individual stock.
If that stock does poorly or the company goes bankrupt, you’ll probably lose a lot of money and perhaps even your job.
One of the most important ways to lessen the risks of investing is to diversify your investments. Don't put all your eggs in one basket.
Have and Maintain an Emergency Fund.
Most smart investors put enough money in a savings product to cover an emergency. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.
Pay off high interest credit card debt.
There is no investment strategy anywhere that pays off as well as, or with less risk than paying off all high interest debt you may have.
If you owe money on high interest credit cards, the best thing you can do under any market conditions is to pay off the balance in full as quickly as possible.
Consider dollar cost averaging.
Through the investment strategy known as “dollar cost averaging,” you can protect yourself from the risk of investing all of your money at the wrong time by following a consistent pattern of adding more money to your investment over a long period of time.
By making regular investments with the same amount of money each time, you will buy more of an investment when its price is low and less of the investment when its price is high.
This is best for individuals that typically make a lump-sum contribution to an individual retirement account especially in a volatile market.
Take advantage of “free money” from your employer.
Employer-sponsored retirement plans often match some or all of your contributions.
If your employer offers a retirement plan and you do not contribute enough to get your employer’s maximum match, you are passing up “free money” for your retirement savings.
Consider rebalancing portfolios occasionally.
By rebalancing, you'll ensure that your investment portfolio does not overemphasize one or more asset categories, and you'll return your portfolio to a comfortable level of risk.
You can rebalance your portfolio based either on the calendar or on your investments.
Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months.
Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you've identified in advance.
The advantage of this method is that your investments tell you when to rebalance. In either case, rebalancing tends to work best when done on a relatively infrequent basis.
Avoid circumstances that can lead to fraud.
Scam artists read the headlines, too. Often, they’ll use a highly publicized news item to lure potential investors and make their “opportunity” sound more legitimate.
In order to avoid investment scams, the SEC recommends that you ask questions and seek unbiased answers before investing. Always take your time and talk to trusted friends and family members before investing.