Where you invest is important, but so is how you invest.
Over time, where you invest is likely to deliver you winners and losers. No investor has a perfect record. Long-term, though, winners should outweigh losers and help you achieve your financial goals.
How you invest, though, will also determine your financial future. You may sell stocks you should keep and keep stocks you should sell. You may run up credit card debt and pay high interest rates or lose money on risky investments. You may invest in the market when prices are high and bail out when prices are low.
Knowing what not to do is, for most investors, the first step toward improving long-term investment performance. So what are some of the most common investment mistakes?
Gambling instead of investing.
Investors often try to “time the market,” buying stocks when they think prices are going to rise and selling when they think prices are going to fall. That’s a quick way to go broke. The world’s best, most seasoned professionals cannot accurately time the market with any consistency. Neither can you.
Not cutting your losses.
It’s good to invest long-term, but that doesn’t mean holding on to a bad investment indefinitely. If an investment turns out to have been ill advised, sell it and move on.
It is more difficult to recover your losses than it is to protect your money. For example, if a stock declines in value by 50%, it will have to double in value just for you to break even. Don’t wait to recover your losses before selling. You may never recover.
Not diversifying sufficiently.
Putting all of your money into one or a small number of stocks is never a good idea. Some companies give employees an incentive to invest in their company stock, but if the company fails to perform well, the employees suffer. Financial fraud, bad business decisions, market changes, new regulations, increased competition, lawsuits and many other factors can cause a business to suffer a reversal of fortune.
If, conversely, only a small amount of your money is invested in a company whose stock implodes, you will barely notice the loss.
Investing in many different stocks is not enough, either. At the least, your portfolio should be include a variety of stocks and bonds. Having a percentage in cash equivalents, such as money market funds, can provide liquidity. Increasingly, alternative investments, such as precious metals and real estate, also are playing a role, even for the average investor.
Your stock, bond and alternative holdings should also be diversified. Stock investments, for example, may be in large-cap, mid-cap and small-cap stocks; value and growth stocks, and domestic and international stocks.
Mutual funds and exchange traded funds provide added diversification, because the average fund typically is invested in many stocks, bonds or alternative investments at any given time.
Failing to plan.
Wealth doesn’t come naturally. You have to plan for it. Start by identifying your financial goals. How much do you need to save for retirement? How many children do you have or expect to have, and do you expect to pay for their college education?
In addition to identifying your financial goals, you’ll need to determine what it will cost to achieve them. Based on your investments, and what you plan to save in the future, what rate of return will you need to achieve your goals?
Adjust your investments over time based on your changing needs and financial status. It is best to project conservatively. Having more money than you need during retirement is better than not having enough.
It takes time for investments to grow in value. Investment professionals typically advise that investors have at least a five to seven-year time frame when they invest in stocks, based on the assumption that it may take that long for the stock market to run through a typical cycle during which the market goes up and down.
Building wealth is a long-term process that requires patience and discipline.
Failing to invest regularly.
Unless you invest a set amount regularly, you may put off investing altogether. You’ll wait until next year, then the year after that, then the year after that. Before you know it, it will be time to retire and you won’t have enough income to support yourself and your spouse.
Saving a set amount every week or every month can help you achieve your financial goals and is also a smart way to invest. Let’s say you invest $100 a month into an index fund. This month, the price is $25 a share, so your $100 buys four shares. Next month, the price drops to $20 a share, so your $100 buys five shares. Note that you are buying more shares when the price is low and fewer when the price is high.
This practice, which is called “dollar cost averaging,” requires continuous investment in securities, regardless of fluctuating prices. Investors should consider their ability to continue to make purchases through periods of high and low price levels. Dollar cost averaging does not ensure a profit and does not protect against loss.
Failing to take advantage of tax-advantaged investing.
Employees today can invest more than ever in tax-advantaged retirement plans, such as 401(k) plans, which allow taxpayers to defer paying taxes until retirement, and Roth 401(k)s, which enable investments to grow on a tax-free basis. They can also invest in IRAs, which are tax-deferred, or Roth IRAs, which grow tax free.
Parents can also save for their children’s college education on a tax-advantaged basis. Contributions to Section 529 plans, for example, are made with after-tax dollars, but any growth in investment values is tax-free.
Tax-advantaged investment allows more of your money to work for you. Investors should take advantage of the opportunity to the extent that they can.
Not owning stocks.
Some people refuse to invest in stocks, because they think they are too risky. Not investing in stocks can be much riskier, because your portfolio will not be properly diversified. Past performance is no guarantee of future returns, but historically, stocks have provided high long-term returns.
Buying “hot” stocks.
Investors sometimes act on hunches, half-truths and tips. Their uncle heard from a friend of a friend whose neighbor is a broker that Triple A Software is introducing a new product that’s going to send the company’s stock soaring. If your uncle knows so much, why isn’t he rich?
Hot” stocks can be found anywhere – in financial newsletters, on television, in your e-mail and online. Except, by the time you read about them, they are unlikely to be hot. The market reacts to information. If a company is expected to perform exceptionally well or particularly poorly, its stock price will likely adjust accordingly before you hear about it.
Failing to seek professional help.
If you don’t invest for a living, you are probably not aware of everything happening in the market that is affecting your investments. You are likely unaware of changes in money managers, SEC investigations, class-action lawsuits and the various other factors that can affect the value of your investments.
Letting a professional handle your investments and help you plan your finances may save you a lot of money long-term.
Over time, investors are likely to make many mistakes. Learn from your mistakes, follow common-sense advice and don’t take unnecessary risk. If you do, you will be more likely to reach your financial goals.