Just with anything in life, mistakes will be made. It's no different when it comes to investing. The important thing to remember is that you learn from those mistakes and refrain from making them a second time around. It’s also just as important to learn from others’ mistakes. If someone you know has a terrible experience with a certain financial advisor, be sure to vet the next one you use. If someone you know invested in a very illiquid venture at a time that they needed the money, make certain that you take note of that the next time a major purchase is on the horizon. With that said, here are 5 very important investing pitfalls (in our opinion), that you should take note of, even if you haven’t experienced them yourself.
5. Being impatient
Investing takes patience. You can’t expect to make millions overnight. One of the worst things you can do is jump in and out of stocks or bonds, seeking the next big winner. All this does is increase transaction costs, trigger tax obligations, and most likely drive you crazy. There’s nothing wrong with attempting to buy the next Apple, Google, or Amazon, but when you think you have it, just give it time. There are many factors that impact a stock’s movement; don’t expect to know all the answers, all of the time. When market pundits suit up for the day and go on air touting their favorite market plays, you’d think that their version of “long-term” would be closer to a week than a year.
For tax purposes, a long-term gain or loss on a stock is considered to be one year, but in actuality, long-term is usually more than a year or two, of course depending on when the money will be needed. Being patient with your money means taking a long-term view with your investments, and the longer you’re in the market, the more probable it is that you’ll be making money.
4. Heeding the advice of market “experts”
Nowadays, it seems like every writer, TV pundit, speaker, and individual investor is an expert when it comes to putting their money to work. It’s great to take notice of what these people are saying, but don’t go changing your portfolio every time someone tells you to buy or sell. Keep this in mind: not every expert can be correct all the time. Yes, some might get it right more than others, but if they really knew what was going to happen in the future, do you think they’d be willing to share it with the world? Chances are they’d put their head down, make their prescient predictions, and live out the rest of their days as multi-billionaires. Listening day in and day out to experts won’t get you far, it will likely just confuse you on who the actual expert is. It’s incumbent on you to become the expert. Our advice is to question anything that a financial advisor or investment manager tells you. Ask questions. Take notes. Be sure to fact check anything you hear, and most importantly, know when something is too good to be true. There are no shortcuts. If it seems like a get-rich-quick-scheme, it probably is just a simple scheme to get your money.
3. Ignoring the costs of doing business
The investment industry is a business. And a big one at that. Just like any other business, it exists to generate profits. It’s not a benevolent endeavor that was created for the good of mankind. So, when you’re looking to invest your hard-earned money, pay attention to all the costs that are extracted to make the investment industry flourish. If transparency reigned supreme in the industry, our guess is that people would be very surprised at the fees, let alone other costs of doing business like taxes, commissions, and the like. Most of the time these expenses come out of your account via automatic withdrawals. Add them up and compare to other players in the industry.
We believe that if investment companies made their clients actually cut a check for each and every fee, people would think twice about who they invest with. The good news is that fees for certain investments and with certain companies have never been lower. No longer are investors subject to sales loads on mutual funds that can add up when the initial purchase is made or when redemptions occur. Pay attention to expense ratios, transaction fees, and assets under management (AUM) fees. If your advisor is charging over 1% of the money you have invested, keep in mind that you’re guaranteed to lose that exact amount year after year, compounded. The magic of compounding returns can also work against you, after all, every dollar of fees that you don’t get to keep translates into a dollar that you don’t get to invest and potentially make money on, compounded over time.
2. Holding losers and selling winners
The narrative goes something like this:
Investor: I bought ABC stock and it’s down 20%. Would you sell now or wait for it to come back?
Friend: Sometimes I sell, sometimes I hold. What are you going to do?
Investor: I think I’ll hold until it comes back, no point in realizing a loss right now, right?
Friend: You could tax-loss harvest if you have any capital gains.
Investor: I’d rather just wait until I’m even, then sell and get out at breakeven.
Friend: What if it comes back and surpasses the price that you bought it at?
Investor: I’ll probably sell if it goes over 10% of my purchase price.
Friend: Really? Why not wait until you double your money?
Investor: Maybe I will.
The point highlighted here is that a clear plan has to be put into place on both the buy and sell side. If you hold losers without a game plan, chances are you’ll never cut your losses. If you hold on to winners too long, you’ll never lock in gains and realize profits. And don’t bank on a stock coming back to breakeven (or beyond) before you choose to sell. Set a limit at a certain percentage, say 15% or so, whereby you cut your losses and allocate your money elsewhere. Do the same for taking profits.
1. Letting your emotions get the best of you
Investing is part science and part art. Computer models are now able to run highly sophisticated algorithms to execute trades by the second. That’s the science part. Fund managers also use intuition and behavioral finance techniques to execute trades based on market sentiment. Good decision-making requires both science and art. Getting attached to a particular stock will only cloud your judgement when it comes time to make a decision on whether to buy more or sell down. Never get attached to a stock, a bond, or any other investment because it’s been good to you at one point. If it’s not good to you now, consider alternatives. Letting emotions dictate the buying and selling you do is a recipe for disaster. Know when to keep your emotions in check.