Four Investing Mistakes to Avoid
Don't Become Your Investment Portfolio's Worst Enemy
When it comes to managing your family's money, there are four investing mistakes that you should strive to avoid. While certainly not a comprehensive list, these errors are frequent enough that both amateur and seasoned investors would do well to keep a watchful eye on the selections of stocks, bonds, mutual funds, and other assets they are considering adding to their portfolios.
Investing Mistake 1: Spreading Your Investments Too Thin
Over the past several decades, Wall Street has preached the virtues of diversification, drilling it into the minds of every investor within earshot.
Everyone from the CEO to the delivery boy knows that you shouldn't keep all your eggs in one basket, but there's much more to it than that. In fact, many people are doing more damage than good in their effort to diversify.
Like everything in life, diversification can be taken too far. If you split $100 into one hundred different companies, each of those companies can, at best, have a tiny impact on your portfolio. In the end, the brokerage fees and other transaction costs may even exceed the profit from your investments. Investors that are prone to this "dig-a-thousand-holes-and-put-a-dollar-in-each" philosophy would be better served by investing in an index fund which, by its very nature, is made up of many companies. Additionally, your returns should mimic those of the overall market in almost perfect lockstep.
Investing Mistake 2: Not Accounting for Time Horizon
The type of asset in which you invest should be chosen based upon your time frame.
Regardless of your age, if you have capital that you will need in a short period of time (one or two years, for example), you should not invest that money in the stock market or equity based mutual funds. Although these types of investments offer the greatest chance for long-term wealth building, they frequently experience short-term gyrations that can wipe out your holdings if you are forced to liquidate.
Likewise, if your horizon is greater than ten years, it makes no sense for you to invest a majority of your funds in bonds or fixed income investments unless you believe the stock market is grossly overvalued.
Investing Mistake 3: Frequent Trading
A lot of folks can name ten investors on the Forbes list, but not one person who made their fortune from frequent trading. When you invest, your fortune is tied to the fortune of the company. You are a part-owner of a business; as the company prospers, so do you. Hence, the investor who takes the time to select a great company has to do nothing more than sit back, develop a dollar cost averaging plan, enroll in the dividend reinvestment program and live his life. Daily quotations are of no interest to him because he has no desire to sell. Over time, his intelligent decision will pay off handsomely as the value of his shares appreciates.
A trader, on the other hand, is one who buys a company because he expects the stock to jump in price, at which point he will quickly dump it and move on to his next target. Because it is not tied to the economics of a company, but rather chance and human emotion, trading is a form of gambling that has earned its reputation as a money maker because of the few success stories (they never tell you about the millionaire who lost it all on his next bet...
traders, like gamblers, have a very poor memory when it comes to how much they have lost).
Investing Mistake 4: Making Fear-Based Decisions
The costliest mistakes are usually based on fear. Many investors do their research, select a great company, and when the market hits a bump in the road, dump their stock for fright of losing money. This behavior is absolutely foolish. The company is the same company as it was before the market as a whole fell, only now it is selling for a cheaper price. Common sense would dictate that you would purchase more at these lower levels (indeed, companies such as Wal-Mart have become giants because people like a bargain. It seems this behavior extends to everything but their portfolio). The key to being a successful investor is to, as one very wise man said, "...
The simple formula of "buy low / sell high" has been around forever, and most people can recite it to you. In practice, only a handful of investors do it. Most see the crowd heading for the exit door and fire escapes, and instead of staying around to buy up ownership in companies for ridiculously low prices, panic and run out with them. True money is made when you, as an investor, are willing to sit down in the empty room that everyone else has left, and wait until they recognize the value they abandoned. When they do return, be it in weeks or after several long years, you will be holding all of the cards. Your patience can be rewarded with profit and you could be considered "brilliant" (ironically by the same people that called you an idiot for holding on to the company's stock in the first place).
More Investing Mistakes to Avoid
Discover other frequent investing mistakes in a follow-up article called Four More Investing Mistakes to Avoid.