Investing is a LONG game, not a quick flip for a few dollars. The goal of investing is to build wealth rather than a get rich quick scheme. Which is where a lot of investors lack in their strategy. Throughout we are going to discuss the top 5 common investment mistakes a lot of beginners make. Not only are we going to break down the mistakes, but also solutions to these problems. This document is written with decades of experience and learning from our own mistakes. This is not advice as to what to invest in and how, but anecdotal opinion. Check in with a financial advisor before investing and making decisions.
Top 5 Common Investment Mistakes That Beginners Make:
- Investing Without a Plan
- Following the Crowd or Social Media Trends
- Trying to Time the Markets
- Over Diversification or Under Diversification
- Leaving it up to Intuition or “feeling”
1. Investing Without a Plan
This is the first mistake a lot of people make when starting to invest and it begins even before choosing which assets to invest in. The start of this mistake is failing to define a goal and how much money they plan to invest. Along with how much money they plan to continuously contribute into the investment plan. Investing shouldn’t be one and done. Here is $50,000. Let’s see where it can take me 15 years. Each year, quarter, or month you should look to add into the principle this is the power of compounding gains.
Then come the goals, are you looking to use this for retirement? Then you should start sooner than later. What kind of retirement are you looking for? Maybe you just want a lump sum, so you are looking for assets that increase in capital. Or maybe you want to have a large portion that generates income. In that case, the investor would look for dividend-paying stocks. Whatever monetary goal you have you should have a sum in mind by X years. Which you can reverse engineer like a financial planner. What expected return do you need to generate this amount based on the years invested and additional contributions. Naturally, you would want to use a reasonable growth rate. 5-10% a year is reasonable, 20-40% annually is unreasonable.
Then comes the asset selection plan, this should hinge on your risk tolerance and expected holding period. If you need your investment in the next 3-5 years, then you won’t be looking at high-risk stocks to play. Rather something with lesser returns and potentially higher dividends. If you have a 20+ year time horizon you can afford to be a little riskier in your asset allocation, keeping in mind you still have a goal to hit.
Investing can be an emotional game, which can really turn on the investor, mistakes, and losses are unavoidable, and the key is how to manage those positions and emotional rides.
2. Following the Crowd or Social Media Trends
Social media and financial information have become more accessible than ever and with that even more toxic than ever. It’s so easy to get confirmation bias from people you follow, even if they’re experts. The reality of the situation is that the real “experts” aren’t on the screens telling you what to buy and when. The Jim Cramers of the world or your favorite “Furu” on fintwit should be taken with a grain of salt. Do your own research and due diligence when investing your hard-earned money. No one cares about your money like you do.
There are a lot of random stocks and names that are being thrown out there with a “buy” recommendation, a lot of these are either new stocks or growth names that can and will in specific market environments like 2021-2022 get obliterated. Take a look at what happened to Cathie Wood. This was the epitome of “even professionals are lost”. The growth-heavy ETF took a massive beat down (ARKK) on high inflation and low company growth. Then you have people like Warren Buffet you can learn from. Value investors that might not have the same investing style as you, however, the philosophies are sound. “Invest in what you understand”. The point is regardless where you get a recommendation for an investment, do your own research and ask yourself “does it align with my plan”. Rather than thinking of the riches, it can bring.
3. Trying to Time the Markets
Every investor out there wants to buy the bottoms and sell the tops, continuously and avoid all drawdowns or market crashes. However, the reality of the situation is that very few people are able to do that and as a beginner, you won’t be able to. Rather than thinking of the market as “timing the market”, think of it as “time in the market”. Meaning the holding period will trump your ability to identify where to get in and out.
Being able to time the market is something experts struggle with, however, if you have a long holding period of 10-15 years, assets that are well selected will continue to grow as long as the company grows. There are continuous cycles in the market, up, down, corrections which are long term and short term, pessimism and optimism that drives these moves. However, if investors succumb to all of the emotions and forget about their overall plan and how these assets were selected they might get trapped in these cycles and experience realized losses before gains. Now each trader should have risk tolerance. Rather than holding a stock out to -60/70%. Make sure that you know where you draw the line.
My favorite example is that of the overall market SPY ETF or even AAPL, which has had 7 splits so far. Even if you invested before all the massive crashes we’ve seen. 2001, 2008, and 2020, you would have experienced dips but overall your net position would increase multiple folds right now.
Take the SPY ETF as an example. Investing in 2006, right before turmoil in the mortgage-backed security market. January 2006, SPY was trading at 125 before dropping to 70 in 2009, now trading at 415 in 2022. From the original position, you are up 235%. Yes, there was a near 50% drop in that period. If your risk tolerance allowed you, as an investor you would’ve been buying more to get a better average. Rather than panic selling, there was the opportunity to buy more and believe in the US economy and the growth potential even during this turmoil. Meaning that your gains if not held out would be lesser and you would’ve realized a loss at that time.
AAPL is another example. Split adjusted, was $3.08 in January 2006, now trading at $145… This is a 4600% gain in the stock. In 2009 it dropped down to break even from your entry, but 50% from its highs in 2007.
The moral of the story, select your assets wisely and you won’t have to time the market. Rather spend time in the market.
4. Over Diversification or Under Diversification
Investors can be over-allocated or under-allocated in specific sectors that can really affect the long-term gains. You don’t need to be a portfolio manager to bypass this mistake but you should understand some basics we are going to lay out here.
There is always a middle ground when it comes to investing. You have probably heard of the saying “diversified portfolio”, these types of portfolios include multiple different assets from different sectors or classes. Which mitigates the idea of having all of your eggs in one basket, of stocks that is. If your portfolio is 100% tech names, then when tech does poorly your whole portfolio will do poorly. This was the case with growth stocks that did really well in 2020, they managed to get really beat up in the following 2-years. Investors with over allocations in growth saw a lot of gains wither away.
A solution to this is having an equity and fixed income split, to begin with, and within each of these you can further split up the allocation. The split between equities and fixed income is based on the stage of your life. Younger investors will have heavier equity split potentially 70 or even 80% of assets, the rest is being fixed income, the closer you get the more even the split becomes.
Within the equity split, you can have different sectors that complement each other and some are less risky like consumer staples, and less volatile, while others like technology names are on the riskier side. Of course, there are massive blue-chip companies in each basket. There is a happy medium of 10-20 stocks typically in a portfolio.
Then, of course, you have over-diversification where you can have too many stocks and too many different sectors that could potentially completely diversify so your gains are overshadowed by losses and the long-term trajectory of the portfolio is muted. Carefully either select a basket of stocks and be able to rotate them. Or instead, use ETFs (exchange-traded funds) which allow you to gain access to hundreds of different stocks through one vehicle.
As beginner investors, the ETF can really be your friend, investing passively is a lot easier and more profitable than stock picking if you are NOT an expert. For example the SPY.
5. Leaving it up to Intuition or “feeling”
Investing should be systematic, rather than left up to feelings. Emotionality is really what drives the market, fear, and greed. You might feel “FOMO” in some situations where a stock is rising rapidly and you miss the move only to buy the top. Then that stock does poorly. Always revert back to your plan and ask yourself “does this investment fit my goals”. Intuition is great but data-dependent investing will always triumph in that space. It works the other way too, if you feel as if you should get rid of a stock because it is slightly underperforming, again ask yourself “what does the system tell me”. “It is within my risk management”.
Overall there are plenty of mistakes to make as a beginner investor and these are the main ones, with solutions on how you can avoid them. It is always best to learn from your mistakes but if you can minimize losses in the meantime you can make it that much better. At TRADEPRO Academy we have some resources for longer-term positions and market movements as a whole that you can take advantage of. We focus a lot of sector rotation and market internals in our options community.
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The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable for your own financial situation. TRADEPRO AcademyTM is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.