Some people seem to think that investing in the stock market or other securities markets is just a matter of luck – buy the right stock at the right time, and you are sure to get rich. Although you can certainly get lucky on the stock market – people do from time to time – your chances are far better in the long run if you take an active part in the investment process and do not simply leave your hopes for the future to chance.
By taking the time to understand your investment goals and then developing your own personal investment plan and guidelines, you can minimize downside risk while maximizing the upside potential to succeed. But make no mistake: you can lose when you invest your money and lose a lot.
In this article, we will go over the most common mistakes you can make when investing. If you avoid these mistakes, you’ll be well on your way to becoming a successful investor and achieving the investment goals you set for yourself.
1. Investing before you’re financially prepared
How long could you survive if you were fired or laid off from your job? How long would your savings last if you were injured and forced to spend several months in the hospital?
How many mortgage or rent payments, expensive tanks full of gasoline for your SUV, or shopping carts of groceries for your family would you be able to afford before your account balance hit zero? If your answer to these questions — and questions like them — is “not many,” you may not be ready to invest yet.
Believe it or not, just because you’ve got some money in the bank or a wallet full of cash doesn’t mean that you should start buying stock or bonds or finding other ways to invest your hard-earned funds. You should first have a well-funded savings or money market account — with enough cash available to help get you through rough financial times or emergencies — before you begin investing. In addition, you should have your credit card and other unsecured debts paid down to a reasonable level.
Until then, you’re not ready, for two main reasons. First, if you someday find yourself in a real financial pickle, the money you have put aside for this rainy day (or the money that is otherwise tied up in liquid assets) will support you and your family until you get your feet back on the ground.
Although you can sell stock fairly quickly if you need to, you may have to sell it at a loss. Most people should have at least six months of living expenses socked away, in case of emergency. If you’re concerned that your job is on thin ice and you have no ready alternatives, save even more — up to a year’s worth of living expenses.
Second, if you’re carrying a heavy load of debt, you’ll probably be making a better financial move by first paying down this debt and cutting the amount of interest you’re paying out each month. So before you start investing your money in stocks, bonds, mutual funds, and other investments make sure you’ve got your financial act together. Investing before you’re ready can stretch your financial resources way too thin and can land you in serious financial trouble before you know what happened to you.
2. Investing without goals
To be effective, every investor needs goals — that is, an idea of what future outcomes he or she wants and expects to achieve. If you don’t have goals, how will you know when you’ve succeeded? Goals give you direction and let you know when you’ve achieved success in the investing approaches you have selected.
The goals you select make a huge difference in your optimal investing strategies. Here we list the common goals for most investors — remember, no right or wrong goals exist. Your goals simply are the ones that you decide are most important for you to achieve.
- Accumulating enough money to retire comfortably — when and where you want
- Building a strong, diversified investment portfolio that can weather the ups and downs of the markets and continue to grow over the long run
- Saving enough money to put kids through college
- Building up a substantial down payment on a dream house — or to pay for a vacation home on the beach in Hawaii
- Buying a new car or truck or big-screen television
3. Believing those “hot” tips
Consider a typical scenario. You’re standing at the water cooler at work, chatting with a colleague and minding your business. Suddenly she whispers in your ear, “Guess what I heard? Acme Widgets stock is about to go through the roof. If you buy now, you’ll make a killing in the market!” People in the investing business call this a hot tip.
But you can’t always believe what you read — or what a friend, acquaintance, or family member tells you, no matter how well-intentioned someone is. Most hot tips are actually not so hot — in fact, they’re often big money losers.
One reason for this fact is that people sometimes hype the value of not-so-great stocks and other investments by starting a whispering campaign about how the stock is about to jump in price. And if you act fast, you can get in before the stock takes off. Of course, instead of taking off as promised, the stock price most often sinks like a rock — usually shortly after you buy it.
Instead of relying on hot tips for your investing decisions, it’s far better to do some research on your own to determine whether a particular investment will help you achieve your goals.
Consider the industry — for example, if gasoline prices are going through the roof, automobile stocks may not be the best investment in the near term. Consider the company: Does it have a history of steady growth, or is it subject to wild swings in revenues and earnings? Consider the investment itself: Has it performed well over a long period of time, or is it in the doghouse more often than not?
4. Invest in a trade or business you don’t know
It is always wrong to invest in a trade or business that you know nothing about. It is a big mistake to get into stock trading if you do not understand the business and financial models involved. You can avoid this mistake by taking the time to research the stock market and stock trading before you invest your money. Educate yourself about the different markets, the driving forces and the trading procedures.
Most investors tend to buy stocks from the newest companies and industries that they know very little about. Although such companies may look promising, it is difficult to determine whether they will continue. If you understand a particular company, you have a better chance than other investors.
You will be able to make accurate predictions about the company or the industry, which can bring you more profit. You will be able to quickly tell when the company is booming, stagnating or closing long before other investors get this information.
People who do not take the time to study companies miss out on the future trends of those companies. Failing to recognise such trends means missing out on several opportunities. For example, a person who invests in a company whose value is higher than his capital can quickly lose his entire investment.
Therefore, it is always advisable to invest in an industry that you understand better. For example, if you are a surgeon, you can invest in stocks that deal with medicine or related topics. Lawyers can invest in companies that generate revenue through litigation, and so on.
5. Not diversifying your portfolio
Life is unpredictable. Just when you think that you’ve got it all figured out — and that the status quo will remain just that far into the future — life throws you a curve ball, and everything you thought was stable and predictable turns upside down.
Stock, bond, and other securities markets act in much the same way, as do the individual financial instruments that make them up. Just when you think you’ve got your retirement funded, as a result of the several tens of thousands of shares of stock you bought in Acme Widgets over the past couple of decades, the company declares bankruptcy, and those thousands of shares of stock that you bought become worthless overnight.
When putting together your investing plan, it’s particularly important to select a variety of different investment vehicles — from stocks in different industries, to bonds, to mutual funds — so that losses in any one financial instrument are balanced by gains in your other financial instruments.
The more diversified your portfolio, the lower the risk of your overall investment strategy; the less diversified your portfolio, the higher the risk. If you want to stick with buying stocks, consider putting together a portfolio of at least 15 different stocks in at least 5 different industries. If your portfolio includes stocks, bonds, and mutual funds, five investments in each of these areas is a reasonable minimum or starting place.
6. Selling too soon (or too late)
“Shoulda, coulda, woulda” are three words that no investor wants to hear come out of his or her lips. The road of investing is littered with the bodies of men and women who sold their assets too soon and lost out on a significant increase in price that was just around the corner or who waited too long to sell their assets and rode the price all the way down to the basement.
Refuse to follow the herd. If people are bailing out of stocks, you probably want to hold on to the stocks that you have while you buy up as much stock as you can at the newly lowered prices. If people are buying up stocks, pushing prices into the stratosphere, you may want to sell. Above all, don’t let the actions of others cause you to panic. Stop, take a deep breath, access your situation, and then act accordingly.
7. Getting Too Attached To a Certain Stock
The essence of trading in stock is to make a profit. Sometimes, investors get too deep into a certain company that they forget that it is all about the shares and not the company itself. Being too attached to a company may cloud your judgment when it comes to stock trading since you may end up buying stocks from this company instead of getting the best deal on the market.
As you learn more about companies, always remember that you are into the business to make money, besides creating relationships.
8. Using Borrowed Money
This is probably one of the greatest mistakes that investors make. Some investors get carried away with the returns they are making. As a way of getting more profits, they borrow money and use it to enter more stock positions. This is a very dangerous move and can result in a lot of stress. Stock trading is like gambling. You are not always sure how much you take home at the end of each trade. It is therefore not advisable for you to invest borrowed money in it.
As you try to avoid these mistakes, you must also avoid getting information from the wrong sources. Some traders have lost a fortune because they relied on the wrong sources for stock information. It is important to isolate a small number of people and places where you will seek guidance from. Do not be a person that follows the crowd. Take time before investing in new stock opportunities. Carry out proper due diligence, especially with small-cap stocks since these involve a lot of risks. Remember, you must trade carefully and implement expert advice if you want to succeed in stock trading.
9. Timing the Market
Market timing results in high investment turnover. It is not easy to successfully time the market. On average, only 94% of stock trading returns are acquired without the use of market timing. Most traders time the market as a way of attempting to recover their losses. They want to get even by making some profit to counter a loss. This is always known as a cognitive error in behavioral finance. Trying to get even on the stock market will always result in double losses.
10. Trading with Emotions
Allowing your emotions to rule is one of the things that kill your stock investment returns. Most people get into the market for fear of losses or thirst to make returns too fast. As a young trader, you must ensure that greed and fear do not overwhelm your decision-making.
Stock prices may fluctuate a lot in the short term; however, this may not be the case in the long term, especially for large-cap stocks. This means that you may get lower profits in the short term, but these may increase in the long term. Understanding this will help you avoid closing trades when it is not the right time yet.
11. Setting Unrealistic Expectations
This always occurs when dealing with small-cap stocks such as penny stocks. Most investors buy such stocks with the expectation that the prices will change drastically. Sometimes this works, but it is not a guarantee.
To make great fortunes, people invest a lot of capital in these stocks, and then the prices do not change much. If these investors are not prepared for such an eventuality, they may feel frustrated and may quit the business completely. However, this is something that you must be able to manage if you want to grow your investment. Do not expect more than what a certain type of stock can deliver.
12. Too Much Investment Turnover
Investment turnover refers to the act of entering and exiting positions at will. This is one other mistake that destroys great investments. It is only beneficial to institutions that seek to benefit from low commission rates. Most stock trading positions charge transaction fees.
The more frequently you buy and sell, the more you pay in terms of transaction fees. You, therefore, need to be careful when entering positions. Do not get in or exit too early. Have a rough idea of when you want to close positions so that you do not miss some of the long-term benefits of these positions.
The stock market is for patient investors. It is a slow but steady form of investment. Although it bears various opportunities that can bring you money, you cannot make enough profit in one day. Most stock investors are always faced with the challenge of being patient.
Some end up losing trade positions before they mature in the quest to make quick money. Exiting the market too early will always cost you some returns. As a new investor, you must never expect your investment portfolio to perform more than its capability, as this will always lead to a disaster. Remain realistic in terms of the time, duration, and resources needed to earn from the market.