Many new investors have started investing, either through a traditional securities brokerage or with one of the new “app” based brokerage firms. No matter how long you’ve been an investor, or whichever firm you choose to buy your investment from, investor mistakes occur.
Mistakes generally fall into six categories. We’re going to break down what these categories are and how to avoid these mistakes.
Don’t just look at the short term
Short term performance is speculative. It’s long term performance that tells the complete story of an investment. While we may be tempted to invest in something that has had good short term performance, longer-term performance measures such as total return (capital gain plus dividends) are better indicators of an investment. While past performance is no guarantee of success, it is often all we have to go on.
Review the financials of the company you want to invest in and ask yourself these questions:
- Is there too much debt on its balance sheet?
- How does this company you are investing in make its money?
- Is this a company that makes a product that is becoming obsolete (think of the compact disc, the DVD, and before them VHS videotape, vinyl records, and 8 track tape players!)
Consider the risks
Concentrating your investment capital in too few areas can put you at high risk. The opposite problem is having your investment capital spread out over too many areas of the economy, which can cause underperformance or give you more risk than if you just invested your money in an index, say the S&P 500. If you are not familiar with using derivatives, such as stock options, this is a place you want to get some training to help you reduce the risk of doing something wrong. Additionally, if you have only been investing for a short period (less than five years), you may have only experienced good stock market performance and this can make you overconfident in your abilities. It’s important to evaluate your experience and how much risk to take with your investments.
Diversify your investments
Have you heard the phrase “don’t put all your eggs in one basket”? Well, that rule definitely applies to investing. The only way to reduce the risk of a specific investment is to have your “eggs” in different baskets. Similar to our discussion on risk, be careful not to over diversify because you risk underperformance or taking greater risks than an index to measure the stock market. Diversify across different asset classes: domestic stocks, both growth, and value, international stocks, real estate investment trusts (REITs), mining stocks for precious metals, high dividend-paying stocks, and stocks that don’t pay a dividend. Don’t forget to put in bonds for steady returns and income, and a cash account like a money market fund. Currencies and virtual currencies are very speculative and require more study and monitoring.
Avoid paying commission and fees
In this modern era, there is almost no reason to ever pay a commission to buy a stock, a mutual fund, or anything derived from these two investments. Also with mutual funds, the annual expenses of operating the fund eat into your returns, so look for lower-cost funds (less than 1%) and definitely no front-end or back-end sales commissions, or 12(b) 1 fees.
Timing isn’t everything
This is a two-part discussion:
- Is the timing of this investment coinciding with an event in our economy or our world, such as the pandemic or a change in tax laws or even a change in the person occupying the White House?
- Are you just using the price of an investment to quickly trade in and out to capture the upside and then when it drops buy it again?
The company you are investing in or trading isn’t important, just its share price. No one can actually time the markets or the price of a stock, but with the use of charts, one can get an idea of when to enter or exit an investment. Few professional investors can actually time the markets, and most don’t try to, they simply set limits on the price to buy and a price when to sell. Greed sets in and if you are not disciplined in setting price limits, then you may sell too late or buy too high.
Be aware of your emotions affecting your decisions
If you are having a hard time with the price of your investments going up and down, and your timing decisions aren’t as good as you like, then your emotions are getting in your way. You may want to have a professional manage your investments for you if you are jumping in and out of investments and not seeing good returns. This is especially true if you are doing short term trading using one of the new “apps” for making investments. Buy and hold has a reason to still exist in this fast trading world we have now live in, and it takes the emotions out so you can concentrate on owning high-quality investments over a long period of time.