Many new investors have begun investing either through a traditional securities broker or through one of the new app-based brokerage firms. No matter how long you've been an investor or which company you buy your investment from, investor errors will occur.
Errors generally fall into six categories. We'll break down what these categories are and how to avoid these mistakes.
Don't just look for the short term
The short term performance is speculative. It is long-term performance that tells the whole story of an investment. While we may be tempted to invest in something that is performing well in the short term, longer term performance metrics like total return (capital gains plus dividends) are better indicators of an investment. Past performance, while not a guarantee of success, is often all we have to do.
Review the financials of the company you want to invest in and ask yourself the following questions:
Is there too much debt on the balance sheet?
How does this company that you invest in make its money?
Is this a company that makes a product that is out of date (think the CD, the DVD, and before that VHS videotapes, vinyl records, and 8-track cassette recorders!)
Look at the risks
If you focus your investment capital in too few areas, you can be at high risk. The opposite problem is that your investment capital is spread out across too many areas of the economy, which can lead to underperformance or give you greater risk than if you had invested your money in just one index, say the S&P 500 If you are unfamiliar with using derivatives like stock options is a place you might want to get training to help reduce the risk of doing something wrong. If you've only invested for a short period of time (less than five years) you may have just had good stock market performance, which can make you cocky in your abilities. It is important that you evaluate your experience and the risk of your investments.
Diversify your investments
Have you heard the phrase "don't put all your eggs in one basket"? Well, this rule definitely applies to investing. The only way to reduce the risk of any particular investment is to have your "eggs" in different baskets. Similar to our discussion of risk, be careful not to over-diversify as you risk underperforming or taking greater risks than an index used to measure the stock market. Diversify across asset classes: domestic stocks, both growth and value, international stocks, real estate investment trusts (REITs), precious metals mining stocks, high-dividend stocks, and stocks that don't pay dividends. Don't forget to set up bonds for stable returns and income, as well as a cash account like a money market fund. Currencies and virtual currencies are very speculative and require more study and monitoring.
Avoid paying commissions and fees
In this modern age, there is almost no reason to ever pay a commission on the purchase of a stock, mutual fund, or anything out of these two investments. Even with mutual funds, the annual costs of running the fund will affect 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:
Does the timing of this investment coincide with an event in our economy or our world, like the pandemic or a change in tax laws or even a change in the person who occupies the White House?
Are you just using the price of an investment to quickly swap in and out to catch the uptrend, and then buy it again when it falls?
The company you invest in or trade with is not important, only the stock price. Nobody can actually time the markets or the price of a stock, but charts can be used to get an idea of when an investment should come in or out. Few professional investors can actually time the markets, and most don't try. They only set limits for the purchase price and the selling price. Greed kicks in, and if you don't set price limits in a disciplined way, you can sell too late or buy too high.
Be aware of your feelings that influence your decisions
When you're struggling to go up and down the price of your investments and your timing decisions are not as good as you'd like, your emotions get in the way. You may want to have a professional manage your investments if you are getting in and out of investing and aren't getting good returns. This is especially true if you are trading one of the new "apps" for investments at short notice. Buying and holding has a reason to still exist in this fast-paced trading world we now live in, and it takes the emotion out so you can focus on owning high quality investments for a long time to come.
Chris Cooper (1 posts)
Chris Cooper, CFP®, EA is a financial expert at Mint. Chris holds a Masters of Science in Financial Services specializing in Financial Planning and a Diploma in Gerontology. He is a CERTIFIED FINANCIAL PLANNER ™ certificate and is approved to practice auditing and administrative procedures before the Internal Revenue Service and state and local tax authorities.
Chris is a member of the National Association of Personal Financial Advisors and an associate member of the California Society of CPA, the Los Angeles County Bar Association, and the San Diego County Bar Association.
Chris was a regular on CNBC and is regularly quoted in newspapers and magazines around the country. He is the author of Eldercare Confidential: Warning Messages for Adult Carers and Parents and Spouses.