When it comes to investing, everyone is always looking for a secret wealth-building strategy that will allow them to outperform the market. But what is important is to avoid mistakes — the kind that can cause you to under-perform in the market or even lose money.
1. Improper Investment Allocation
Though the emphasis is usually on investment selection, proper investment allocation is just as important.
You have to come up with the right mix of investment assets to suit your position in life, your risk tolerance and your investment goals.
Too much money in stocks and you can get burned in a crash. Too much money in fixed-income investments and you’ll be clobbered by inflation.
2. Emotional Investment Behavior
Investors often get overly confident in bull markets and panic in market sell offs. That’s the perfect recipe for losing money.
The greatest success in investing comes when you can flip that arrangement around — when you can buy during a market sell-off. It’s a tough discipline to master and one that requires getting control of your emotions.
3. Ignoring Fees
Investment fees matter! A two or three point reduction in your portfolio return on investment can cut your returns dramatically over 10 or 20 years. Keep your money with low-cost brokers and favor low and no-load mutual funds.
Investing is an exercise in patient capital. Some investors, however, like some action with their investing.
Not only can haphazard investing patterns (read: no real investing strategy) lead to erratic behavior but it also creates a rapid run-up in the amount of transaction fees you pay. As discussed above, that will take a big chunk out of your investment returns.
5. Failing to Diversify
No matter how well the stock market is doing, you need to have at least some money held back in cash and fixed-income investments. Not only will this reduce the volatility of your portfolio in a down market but it will also provide you with plenty of capital to buy stocks after a big sell-off.
On the flip side, no matter how bad the stock market is doing, you need to have at least some money invested in them in the event of a quick and unexpected recovery. Timing is never certain, so you need to have at least some money in the market at all times.
That’s diversification — a mix of high risk and low risk investments that will make timing the market less critical. (Note: not that you can time the market anyway, but just in case you think you can.)
6. Getting Wrong Investment Advice
Lots of people get their investment advice from the popular media. I’m not going to name names here, but some self-styled investment media gurus have built up quite a following making rapid-fire investment recommendations.
Here’s a clue: Media financial types ultimately make their money from program sponsors — guess which stocks they are going to recommend?
7. Buying Investments You “Love”
Never fall in love with an investment, whether it’s a stock, a sector or even an entire asset class. When you start believing that investment “can’t lose”, you’re about to get run over by a bus, financially speaking.
The fact that an investment has performed well in the past is not a guarantee of future performance (sounds familiar, doesn’t it?). At the same time, just because you think the company has a great product, or the company itself gives you that warm fuzzy feeling, doesn’t override the fundamentals.
Financial position, industry trends and even regulatory environment will trump positive feelings every time.
8. Not Analyzing a Company’s Financial Statements
If you are traveling to foreign countries for an extended period of time, you have to learn the language the people speak just to get around. Investing has it’s own “language” — they’re called financial statements, and they represent the financial health of a business.
You have to know how to read and analyze financial statements if you are going to invest in individual stocks. That analysis will tell you what’s really going on with the company, beyond public pronouncements and media clutter. It’s a mechanical process and one you should learn, if you’re going to be a serious investor.
9. Underestimating Risk Exposure
You have to understand the connection between a business or a sector and the risk that’s involved. Investors often don’t.
For example: in an effort to profit from India’s phenomenal economic growth, investors may invest in Indian oil stocks. While that may give reasonable exposure to India’s economy, it also adds the risk of oil prices to the mix.
The stock or fund could decline — not because of problems with the Indian economy — but because of a decline in oil prices. Before investing in any stock or sector, be sure that you understand all of the risks and that you’re not taking on more than is absolutely necessary.
10. Ignoring SEC Filings and Prospectus
There really is no such thing as a buy-and-forget investment, at least not when it comes to the stock market. Circumstances are changing all the time and often you will only find out just how much by reading the company’s SEC filings.
If you’re investing in mutual funds or exchange traded funds, the fund’s prospectus is required reading. That’s where you will learn exactly what it is the fund invests in. A good example is bond funds, as many different investment vehicles qualify as “bonds”.
A government bond fund you think invests only in U.S. government securities, could also include government bonds from other countries. The fund might hold a percentage of investments in higher-yielding foreign government bonds in order to increase yields on the fund. You would only know that by reading the fund’s prospectus.
Investors who make the fewest mistakes will be those with the best performance. The mathematics are obvious: It takes an 11% gain to erase a 10% loss; a 100% gain to erase a 50% loss. So the fewer mistakes you make, the better your portfolio will perform.
Have you ever made any of these mistakes? What others would you add to this list?