My father used to say, “We teach by example, but we learn by experience.”
Nowhere is this more true than with investing.
Investing mistakes can be costly, not just in dollar terms, but in terms of reaching your goals. I want to save you the experience of making these mistakes so that you can learn from my example.
1: Watching the markets daily
This is a very common mistake, even with experienced investors.
While there’s no harm in being an informed investor and keeping an eye on the stock and bond markets day to day; there is harm in watching every move and constantly checking your balances.
“…there’s not harm in begin an informed investor…”
One key to avoiding investing mistakes and find success is managing your emotional responses to market movements. Investors who watch the markets constantly are typically more vulnerable to other mistakes because they are overly worried about the day-to-day fluctuations of their investments.
I don’t watch the stock market all day long. You shouldn’t either.
2: Chasing returns or trendy investments
The stock market is very efficient, making chasing returns and trendy investments incredibly counterproductive.
If a particular company, fund, or strategy, has already run up in price; chances are there’s not much opportunity left.
Chasing returns and trendy investments can lead to higher annual tax bills, transaction costs, and depressed returns over time as you abandon one investment after another to chase the next hot thing.
Read: In Praise of Simplicity
3: Trying to time the market
The stock market is unpredictable in the short term. Anyone who tells you they know with 100% certainty where the market is headed moment to moment or day to day, is either deluded, or lying.
“No one knows days to day, which way the stock market will go.”
However, the stock market is highly predictable in the long term. The general direction over long periods of time is up.
As an individual investor, trying to time a trade for something you’ll leave invested for five years plus is a fools’ game. And if your investment time horizon is less than five years, you probably shouldn’t be investing those dollars in something as unpredictable as the stock market.
4: Ignoring time horizon
How long your money will be invested should be a direct input in deciding how to invest it. In general, the most unpredictable investment is stocks. The most predicable is cash; bonds fall somewhere in the middle.
Cash is where that dollar should be invested if you need a dollar within 12 to 24 months.
If you need a dollar within two to five years, bonds could be a good place for that dollar to be invested.
If you need a dollar five or more years from now, stocks could be a good place for that dollar to be invested.
If you ignore time horizon, you could find yourself lacking the money you needed for your goal due sudden downturn.
5: Lacking a clear goal
You can’t know your time horizon if you don’t have a clear goal. For example, if your only goal is to save for retirement and you are currently in your 30s or 40s, your time horizon is long. You can take more risks and maybe own more stocks.
If your only goal is to have an emergency fund, there’s no way you should own stocks. Emergency Funds are for immediate cash needs and should always sit in cash.
“A clear goal will help you decide how to invest.”
If your goal is to send your children to college and they are still in grade school, you need to find a mix of stocks and bonds so you can achieve growth but not be subject to losing a substantial portion of your investment if the stock markets turn right before they start school.
Goals dictate time horizon and time horizon helps dictate the risk you take.
Read: Setting Financial Goals
6: Taking too much or too little risk
Risk Tolerance is something I see investors ignore all the time. Nearly every first draft of a Financial Plan that I do involves a recommendation to adjust the clients’ investments because they are taking too much (or too little) risk.
Taking too much risk can cause you to panic in a downturn and sell at the worst possible time. Panic selling can seriously damage your long-term returns and set your plan back by years.
Taking too little risk can cause you to give up potential returns over time. That might mean you need to save a lot more for your goals or even cut back on those goals.
7: Failing to diversify
Diversification, the act of dividing up your investment dollars among different asset types, is a key risk mitigation technique that investors often ignore.
Read: What is Diversification?
There are many ways to diversify. You can diversify across asset types. This means owning some cash, stocks, bonds, and maybe some other assets like precious metals, real estate, or commodities.
“Diversification is key to investing success over time.”
You can diversify within an asset type. For example, you might own a variety of different types of stocks. That is, you might have growth stocks, value stocks, small-cap stocks, mid-cap stocks, large-cap stocks, and international stocks.
If you own a lot of different kinds of investments, if something happens to any one of them, the damage to you is limited. It’s much more painful to take a hit to 20% of your portfolio than to only 2%.
8: Failing to scrutinize costs
As an investor, very few things are in your direct control; but cost is one of those. You can’t predict where the stock market will go each day or how much return a given investment will generate over time, but you can predict what an investment will cost.
The dirty secret many money managers don’t want to talk about is that higher fees, in and of themselves, don’t often lead to investment success. This doesn’t mean that fees are always bad, but it does mean you should be paying attention to them.
“Pay attention to fees and internal expenses.”
Understand what your investments cost, why you pay what you pay, and the impact on your results. If you know those things, you can make better decisions over time.
9: Not having an investment philosophy
Add this to the list of things many individual investors ignore.
An investment philosophy is nothing more than a set of beliefs about investing. Just as many of us have a personal philosophy (or moral code) that informs our daily choices. Similarly, each investor should have a set of beliefs about investing that guide their investing choices.
“An investment philosophy is…a set of beliefs about investing.”
For example, my investment philosophy is that investments should be simple, cheap, and boring. If an investment isn’t simple to understand, cost-effective to buy and own, and boring enough that I don’t feel compelled to look at it often, it’s not right for me.
My decision-making around investments for myself is incredibly easy because I know exactly what I want. More importantly, I know what I don’t want.
10: Working with the wrong Financial Advisor
Inertia gets us all.
That doctor we don’t really like, the CPA who never files our taxes on time, that yard guy who never does the edging how you like it - they never get fired because finding a new provider can be a lot of work. As they say, “It’s the devil you know.”
The wrong Financial Advisor can leave you with unmet needs and could make it hard for you to reach your goals.
A Financial Advisor is at his or her most effective when there is a bond of trust, transparency, and a good match between their skills and your needs.
For example, if having a Financial Plan is really important to you, but your Financial Advisor doesn’t offer, or doesn’t enjoy, Financial Planning, are your needs really being met? Will you reach your goals?
Scrutinize the relationship with your Financial Advisor. Do they provide what you truly need? If not, advocate for yourself to get what you need or find a provider who offers what you need.
Mistakes are largely unavoidable, and no one should allow perfection to be the enemy of good. If you can avoid most of the mistakes I’ve outlined above, you’ll have a much better chance of meeting with investing success.
Ready to make a change? I’m here to help you avoid making investing mistakes and achieve your financial goals.
Diversification and asset allocation does not ensure a profit or protect against loss. All investments carry a level of risk, including loss of principal.