You know that investing is necessary if you want to efficiently grow your wealth, but the recent stock market volatility caused you to be wary of investing. However, it is folly to avoid investing altogether, and even though you might be concerned about it. Look. There is no way to completely protect yourself from the risk of loss, but there are things you can do to reduce losses. Here are five investment mistakes to avoid:
- Time the market: This is especially tempting. You might want to try to time the market, pulling money out when things start looking shaky, and trying to enter the ground floor. However, there are disadvantages to this tactic — one of the biggest being that the market is notoriously hard to predict with high accuracy in the short term. On top of this, you have to pay transaction fees, and if your timing leads to short-term capital gains, you could pay more in taxes. While you might not get a big score by keeping with a long-term strategy that includes dollar cost averaging or buy and hold or others, you are more likely to earn solid and reliable returns over time.
- Give in to market hysteria: Whether it’s the hysteria to buy or the hysteria to sell, giving in to market crazes can be a huge mistake. While you might feel safe going along with everyone else, you are probably making a huge mistake. Buying hysteria creates bubbles that can be suddenly devastating when they burst. If you sell because everyone else is, you might find that you are taking a loss on a fundamentally strong investment that will recover in a couple of years. The bottom line is that you need to base your investment decisions on reasoned research, not hype, and consider buying, even when everyone else is selling.
- Overconfidence in your abilities: During a bull market, chances are that your gains aren’t due to your genius stock-picking abilities, but probably due to the fact that everyone is up. Unfortunately, many amateur investors (and that’s most of us) get an idea that they have more ability to pick stocks than they have. This overconfidence can lead them to take bigger risks, thinking that their crack insight will ensure a big payday. In reality though, most average investors are better off with a strategy of regular investing in solid stocks, funds and other instruments that help them see solid — if boring — returns over the long haul.
- Too much trust in someone else: Whether it’s a stockbroker or a “hot source”, too much trust in someone else can land you in investment trouble. A stockbroker is actually looking to make money for him or herself. A financial adviser that gets commissions from recommending certain financial products and investments isn’t thinking about your best interests. Who knows why a “hot tip” is given. In the end, it is important to consider where your advice is coming from, and do some of your own research. A healthy balance between getting advice from a professional, and figuring things out on your own is a good thing. (Editor’s Note: for some reason, I keep thinking about “hot sauce” when I read “hot source”. Like the former, a hot source is good in moderation, but the more you add, the more you think you need. It’s not because they are good for your body, but because your tongue became insensitive.)
- Pay too many fees: You want to be careful of the fees you pay. Fees eat into your returns. Frequent trading racks up the transaction fees, commissions take money from your pocket and put it into others’, and tax inefficiency results in the government getting more than its fair share. Consider the types of funds and other investments you have, and try to find those with low fees, low turnover for added tax advantages.
In the end, you want to maximize the money that you keep, using it to work for you, and build your wealth. If you are careful to avoid the worst investment mistakes, you are likely to do well in the long term.
I can never stress this enough. Long term people. ALWAYS think long term!
Editor's Note: I've begun tracking my assets through Personal Capital. I'm only using the free service so far and I no longer have to log into all the different accounts just to pull the numbers. And with a single screen showing all my assets, it's much easier to figure out when I need to rebalance or where I stand on the path to financial independence.
They developed this pretty nifty 401K Fee Analyzer that will show you whether you are paying too much in fees, as well as an Investment Checkup tool to help determine whether your asset allocation fits your risk profile. The platform literally takes a few minutes to sign up and it's free to use by following this link here. For those trying to build wealth, Personal Capital is worth a look.
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“Whether it’s the hysteria to buy or the hysteria to sell, giving in to market crazes can be a huge mistake.”
I really will never understand doing this but I see to many doing it. Back in 2000 my coworkers were putting every dime they could into the market. By the middle of 2001 they were selling out. People were selling out in March of last year. What a nice way to lose your shirt.
Regarding point 2, overconfidence in your abilities, I suggest you compare your returns to an index. Rather than looking at the absolute return, the relative one is more helpful. Theoretically, anyone can get the same returns in an index fund, so it’s the amount above that return that you should be proud of.
I always wondered if using dollar cost averaging is such a good idea since if you have to invest same amount every month, then you’ll have to pay 12x more fees. But I guess if you earn more to compensate for these fees in the long run, it would still be a good strategy.
You make a good point. It’s a good idea to check the fees before you get too into dollar cost averaging. Many places now will allow you to have reduced fees if you set up a regular, automatic plan. And, if you don’t have a big lump sum, dollar cost averaging may be your only choice. But you can usually make more than enough to offset the fees.
I don’t know much about investing just yet but I’m interested in starting next month. There are so many things to learn. Hopefully if I follow your tips, it will guide me in the right direction.
I know what you mean. My first investment experience was in a managed fund courtesy of my insurance agent. Yeah. Live and learn, indeed.
Insurance agent?.? Yikes.
No more managed funds for me unless it’s a widely known fund because chances are good that you are paying someone else some commissions just by owning it.
No kidding. I was young. And none too bright.
No kidding…Never understood why people would default to specific agencies who have “expanded” their services.
Think of the context. You could go to a surgeon for a crown or a dermatologist for an appendectomy. Both could probably perform the task, but someone who specializes in that field would do a better job.
I have made the mistake with fees in the past, luckily I caught it early and am going to be moving my minimal investments into a no fee mutual fund. It pays to be fully educated of your options and I wasn’t. Live and Learn I guess.
A good starting point is actually the fund recommendations of all the major money magazines. Kiplinger, Money Magazine etc…
While they are very generic suggestions, at least you won’t be looking at “bad” options.