Investors lose money all the time, even in the middle of a rip-roaring bull market, but knowing the most common investing mistakes that other made before you could help save you big bucks.
Investors lose money all the time, even in the middle of a rip-roaring bull market. Sometimes it’s simply because they picked a stock that didn’t perform, but other times it’s because they’re making common mistakes that cost them big time over the course of a few years.
Knowing the biggest investing mistakes that countless others made before you could help save you big bucks, even in a bear market.
Investing money in the stock market is scary business, especially after the financial crisis of 2008. Many investors decided not to get back in the market at all — a big mistake considering the gains since 2008 — while others are just now getting back in.
See if you’ve committed one of the following offenses and maybe you can avoid making such a mistake again.
1. Selling at the bottom
No matter what reason causes you to do this, it’s a mistake and a fairly common one. Typically, people hold onto stocks because they just want to see it get back to even, then they’ll sell. Or they’ve lost so much money that they can’t bring themselves to sell it now.
The best thing is to cut your losses early if a stock isn’t performing well. After all, the famous saw is “buy low, sell high.” But if you sell low and invest in winners, you’re not making any money.
Not every investment will increase in value — professional investors take hits all the time.
2. Buying at the top
The typical mom-and-pop investor doesn’t get back into the stock market until it is at the top. In fact, when these average investors finally feel confident enough to get back into the market after a dip, it’s usually a death knell for the bull market.
Alexander Green over at Investment U loves to quote investor and businessman John Templeton, who once said, “Bull markets are born on pessimism, grow on skepticism, peak on optimism and die on euphoria.”
When investors are scared, that’s a good thing. You never want to get in the stock market when all anyone can talk about is how much money they’re making — that’s a sure sign that a bear market is coming.
The smart investors buy when the market is at a bottom because everything finds its way up again. Just look at the huge earnings people made from the lows of 2008 to the historic highs of now.
3. Trading too much
Research has show that people who trade more actively, make less money. Actually, the study from finance professors Brad Barber and Terrance Odean showed that, overall, men make less in the stock market than women because men buy and sell more often. The long-term buy-and-hold strategy seems to be better, especially when you consider transaction costs that will cut into any returns.
4. Chasing performance
Perhaps you’ve heard the saying, “past performance does not guarantee future results”? Just because something did well in the past does not mean it will continue to do so. In fact, if you chase a performance, it’s too late — you’ve likely already missed the boat. The people who made money where those who were already in before the investment took off.
“If a particular asset class, strategy or fund has done extremely well for three or four years, we know one thing with certainty: We should have invested three or four years ago,” Investopedia puts it simply.
5. Buying with the herd
Similar to chasing performance is the herd mentality that causes financial mania. If everyone is talking something up, you never want to go all in on that. Remember the dotcom bubble and the housing bubble? Those are prime examples where everyone was convinced tech stocks could never go down because the internet changed everything, and the price of real estate would only increase because they’re not making any more land.
6. Making emotional decisions
Humans are flawed beings. When we let our emotions take over, we do things like selling a stock at the bottom and buying with the herd. Emotional decisions lose you money.
There are ways to take emotions out of investing, though. For instance, investors can set up a stop loss at the beginning when they are still rational. Then, as the stock increases, adjust the stop upward so you can make money, but if the stock falls below a certain price, you get out automatically without emotions getting in the way.
Emotions don’t just make it difficult to sell losers, but to keep winners as well. As a stock increases, investors get more and more worried that it could fall and all that money made will be reduced. A stop loss will also help here, so you can let a winning stock run without having to worry when is the right time to sell and harvest gains.
7. Stock picking
At the beginning of every year there are tons of stock predictions: top 10 stocks to invest in for the new year, top 10 stocks with the most upside, etc. There’s no harm in looking at this lists, but the average investor might want to steer clear of investing in an individual stock, which increases risk. Even the professionals mess this up. At the end of 2010 Barclay’s picked its top picks for 2011 and among them was AMR Corp., the parent company of American Airlines, which went bankrupt that year.
Funds give investors broadly diversified portfolios that can offer some protection from the fluctuations of the market. Investors never want to put all their eggs in one basket; instead, they should be looking to invest in many different sectors.
8. Not rebalancing
Diversifying your portfolio isn’t enough to get peace of mind — it only works for a little while. It’s never smart to make an investment and forget about it. Even (sometimes especially) when the market is doing well, you need to rebalance your portfolio. Investors should take some gains and reinvest them in a different sector.
Plus, as the market moves up and down, your current portfolio mix could be different from you target mix. You may have started in 60% stocks and 40% bonds, but after a hot bull market that may change to 80%/20%, which leaves you vulnerable to the next bear market. You’d better rebalance that portfolio to keep your exposure to stocks in check.
9. Not paying attention to fees
The main reason why buying and selling a lot works against investors is because they’re paying fees. According to Business Insider, the average mutual fund charges up to 3% of annual returns. The fees investors are paying are difficult to offset, and so the fund underperforms the market.
Unfortunately, many investors don’t even know the specifics of the fee structure their investment service provider uses. They could be paying fees they don’t know about, they could be triggering fees they could have avoided.
10. Too short of a time horizon
A long time horizon works far better for investors. Remember the buy-and-hold strategy mentioned in mistake number three, trading too much? A study showed that 92% of the rate of return in a diversified portfolio is the result of proper asset allocation.
If you have a 20- or 30-year time horizon, then what the stock market does in the next five years won’t matter. A bear market won’t hurt your investments as much because if you hold on, then you can make it all back and then some.
And if you have a short time horizon, then you’re asset allocation should reflect that by being more conservative.