Investing is a great way to build wealth over time, but is not something you should dive into without sufficient market acuity and firsthand experience. Learning the most common mistakes investors make can help you protect hard-earned capital and identify profitable investment opportunities as they present themselves.
Thinking an Investment Class Is Risk-Free
For instance, many inexperienced investors claim that index funds are the only assets you need in your portfolio because of their relative low-risk, high-yield nature. However, index funds are not the safest asset, not even Vanguard’s 500 Index Fund, which is basically the largest fund in the category.
Ignoring the Power of Compounding
Compounding only becomes more powerful the younger you start investing capital. Unfortunately, most people are unaware of this force. They open different sized positions that’s calculated solely by their gut feel of the market or whatever irrelevant factor they are using.
To illustrate the power of compounding interest, let’s say you open a bank account worth $100 that yields an annual interest of 5 percent. If you withdraw the earned interest rate every year, you would end up with only $150 in 10 years. However, if you leave that earned interest in your account, it will compound over the 10-year period and yield $162. This may seem like peanuts, but when replicated in a much larger scale, say $100,000, the compounded interest can add up considerably.
In order to be profitable, investing requires tons of patience. Unfortunately, most people grew up being taught to expect instant gratification for their efforts. Both investing and life does not work that way. There will be times when an investment will be in negative territory for several months only to turn around and make a killing. Stocks and mutual funds you invest in will not always go towards your direction at the exact moment you want it to and at the pace you expect it to.
Price never moves in one direction forever. It is bound to reverse sharply in the future. Inexperienced investors can get easily caught up with this illusion that their profitable positions are going to climb up infinitely. Once fundamentals change and sharp falls or rises occur, they give back most of their gains to the market and even lose some. Bulls make money, bears make money, pigs get slaughtered, as the famous Wall Street proverb goes.
After a string of wins, it is human nature to feel unstoppable. You immediately feel like you know how the markets think. This overconfidence leads to placing more trades that weren’t part of your investment strategy. Once their stocks or index funds incur losses, you become panicky and from thereon it’s a snowball effect on your account balance.
Quitting Their Day Job
Perhaps the most common mistake in terms of decision-making is leaving your day job. Investing is not a sure thing, regardless if you’re using the latest software or the services of the top hedge funds. An investment can be worth millions in the future, but can also have zero value. The latter should always be your expectation. Do not leave a paying job just because you’ve started investing in the stocks or bond market.
Keep these rookie mistakes in mind when starting to construct your investment plan. It will make your financial venture easier, less stressful, and more profitable.
Checking Your Investments Too Frequently
It is common for investors to check their investments frequently, but you should avoid doing this. Checking your stocks on a quarterly basis when the reports are sent is frequent enough. It’s very difficult for investors to not constantly watch their stocks, however. When you check your investments too often, it can lead to an over-reaction to small events and make you focus on the share price instead of on the company’s value. This can cause you to feel like you need to take action when none is warranted.
People who constantly check their stocks may engage in trading overactivity. This can cause you to amass fees and harm the value of your investments. If you do see that there was a sharp change in the price of your stock, you should instead research to learn what caused the fluctuation. In most cases, price fluctuations have little to do with how a company will do over the long term. If you see a fluctuation, you should instead remain calm and resist the urge to engage in trading overactivity. It is best for you to simply wait to receive your quarterly reports instead of scouring the data about your stock’s performance every day.