7 Common Investing Mistakes
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TaxBrackets.org We all make mistakes.
Looking back on my years of investing, I notice some small and some big mistakes I’ve made along the way. As I’ve talked to other people, I’ve found that others have made the same mistakes. In order to help you learn, I’ve complied this list of the top investing mistakes. (See also: Investing With Your Values)
1. Starting to Invest Too Soon
Conventional wisdom says invest now, but there are reasons not to invest now.
Many new investors hear a story about some gal tripling her profit in three months and rush home to tell their spouses they need to start investing. Within a couple of days they own stock, but they don’t know a lick about stocks or the stock market.
There is a right time to start investing.
Start investing when your finances are in order. For example, you might consider paying off credit card debt before you start investing.
Start investing when you’ve learned how to start investing. Don’t invest in anything until you have at least a basic understanding of how that investment benefits you.
2. Paying Too Much to Buy and Sell
There’s a great place to buy and sell stock, mutual funds, and index funds. You’ve probably heard of it — it’s called the Internet. Buying and selling online is so simple, and it is a competitive market. That means you can save some serious money by choosing an online discount stock broker.
3. Focusing Too Much on Fund Fees
You might think that #2 and #3 contradict each other, but we’re talking about fund fees, not trading fees. Sure, fund fees are important. If you can get the exact same product for .5% fee instead of 1% fee, then that is a good choice.
However, you might have one mutual fund that charges 2.5% management fee and one that charges a 1% fee. So which is better?
If the one fund has an average annual return of 10% and the other 15%, then the 15% fund is better no matter the fees you pay to own that fund. Returns are more important than fees.
4. Discovering Your Risk Tolerance at the Wrong Time
Everyone has a high tolerance for risk when the market is going up. Hey, I’ll take a risk to gain an extra 10% this year. But then when the market turns, you find out that you just lost an extra 10% because of the risk you took.
It is often in the middle of a bear market that people decide to sell. They sell because their losses are greater than they anticipated.
5. Changing Your Investing Strategy Based on Market Conditions
Let’s say a person was going to invest $100 every month for the year. However, after a couple of months that person sees that he has a loss, so he decides to stop buying until the market goes back up. It seems like that would make sense, but it is a very bad move. It means you actually pay more because you waited for the price to go up.
In fact, that is one of the strengths of dollar cost average and value averaging — they can be effective in good and bad market conditions.
Yes, you may need to re-evaluate your strategy based on market conditions, but don’t let your investing approach change with every ebb and flow in the market.
6. Looking for Hot Stock Tips
If you listen to any talking head who knows which stock will skyrocket next month, you should run for your life.
Investing hot tips are for movies. In real life, people realize no one can predict what’s going to happen next. Don’t believe me? Ask 100 investing professionals if the market will be up or down this year, and I doubt you’ll find more than 10 people who have the same prediction for the same reasons.
7. Paying Outrageous Fees for Investing Advice
Several years ago I fired my financial advisor. The reason was that he would only advise I buy mutual funds that had a 5% front-end load. That’s how he made his money. That’s how I wasted money.
Too many of us think professional financial advisors have some hidden knowledge. They don’t. Getting financial advice is good, but just don’t pay outrageous amounts of money for it.
What other common investing mistakes have you encountered? Have you made any of these investing mistakes?
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Great post Craig. Thankfully, my wife and I decided to pay off debts before we started investing. Well, actually, I got a little antsy and threw some money in the market while we still had student loans. Luckily, I came to my senses (after making a little money, thankfully) and put it all towards our loans.
I like your comment about the "hot stock tips" as well. These almost never pan out. I work in an office building and hear about so many crazy investment ideas. They almost always crash and burn.
I have been following Dave Ramsey's plan for about 2 years and I will be 100% debt free in August of 2012. House and everything! The plan works--but only if you are focused and have self-control. I will have paid off a total of $100K in the four years. I talk about my path to debt freedom in my blog.
Dollars Not Debt
This is a nice article with a number of good tips, but I think that 1 of your tips is incorrect and another could use some clarification. The one about waiting until debts are payed off should be clarified to explain that it makes sense to pay off high interest debt first, but when you get to low interest student loans, the decision becomes a lot more difficult. The bigger issue is with #3. Morningstar released a report recently that showed that expense ratio was the single best predictor of future returns. Looking at a fund's previous returns can be dangerous, especially if you are only looking at recent annual returns. Expense ratios, on the other hand, have been an accurate predictor of returns of over all time spans examined by Morningstar. To quote their report "Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance."
Good practical advice. The only one I take issue with is #3. Large management fees rarely make sense in the long run. A 2.5% management fee versus a 1% fee would mean that one fund would have to consistently outperform by 1.5% per year. Given the average annual expected return is in the 8% range, taking 1.5% additional in fees would rarely pay off in the long run.
Thank again.
Ken Faulkenberry
Very interesting. The very first section threw me off at the beginning but it is true. Many people jump into investments that they aren't ready for yet. You also brought up risk tolerance, hot stock tips and changing investment strategies...GREAT, GREAT advice. To remedy many of those situations I would suggest paper trading for at least a year to understand market cycles.
#3 is not good advice. higher fees can kill your long-term returns, and a fund's past performance is a weak predictor of future success. no-load index funds are the way to go for most investors.
I do agree with you that many people start investing to early. There is need for huge care and knowledge when you are investing in market specially in stocks. Stock investments need huge knowledge and wisdom.
I certainly agree with #1. I know plenty of people that are in debt, from college loans, credit cards or car loans and they ask me "what should I invest in?". The first thing I always ask is the interest rate on their personal debt. They usually say between 4% and 8%. So, this means they would need to find an investment with a guaranteed return greater than 4-8% interest rate to make the investment worth it. This simply does not exist. Come back to me for investing advice when you do not have personal debt. It just doesn't pay for you to invest if you are paying interest greater than your investment could ever earn.
Some great points...but I think #1 might be a bit too much. Don't start too early? One of the best things you can do is stop procrastinating and get your money working for you ASAP! It takes time for money to grow, and the longer you sit on your hands the more of it you're losing! Of course you should go in educated etc, but you don't have to be an expert to get started. Waiting for the "perfect moment" is not good advice.
I spent the better part of my university career working for a small trading desk. It took me two years to realize the importance of creating a plan when it comes to trading or investing. Perhaps it was because I was young and foolish but regardless, until you sit back and think about what exactly it is that you're trying to achieve with each trade or investment, you're bound to fail. Word of advice to the beginners or less experienced. You must have a game plan that you adhere to at all costs.