Getting started in investing is easy. Making the right investment moves is a lot harder. If you’re a beginner investor, you can spare yourself a lot of losses if you just avoid making these 10 big mistakes.
Mistake #1: Not Having a Trading Plan
You can make some big mistakes before you even start investing. Long before you’re buying, selling and trading, you need to think strategically. You need an investment plan that encompasses everything from your capital and goals to your overall financial situation.
When to Start Investing
In terms of compound interest, the sooner you get started investing, the better — in general. However, investing is only one part of financial planning. Jumping right into the stock market while neglecting the big picture of your financial situation could cost you in the long run.
If you’re starting out investing already weighed down by high-interest debt, you may be better off using that capital to pay down your debt first. You’re unlikely to see gains that outweigh what you’re paying in interest costs.
What Capital to Invest
You also don’t want to neglect your savings in favor of investing more capital. Adults should have an emergency savings fund that’s more secure than the stock market, just in case.
Don’t invest money that you need in the short-term, like the down payment for a home you’re planning to purchase next year. If you lose money, you won’t have enough time to regain it before you need to pull that capital out.
Be careful investing borrowed money, as well. Brokers may offer you the option of buying assets “on margin,” with their money. This practice amplifies the reward but magnifies the risk. As tempting as it is to go all-in (and then some) on the next big idea, it’s rarely wise to invest money you don’t have.
What’s Your Goal?
“Making lots of money” isn’t a goal.
Sure, that’s what every investor wants, but this wish is too vague to guide your investment strategy. Without a coherent strategy, you’re not so much investing for your financial future as you are gambling.
Ideally, you’re looking at mid-term and long-term goals. (Due to the risk of losing money, investing isn’t the best choice for short-term financial goals). Do you want to retire early? For young and middle-aged investors, this is probably a long-term goal. A mid-term goal may be anything you anticipate happening in the next several years, such as saving a down payment to buy a home in three years.
Your goals should be specific enough to be meaningful. One way to approach setting specific goals is to ask yourself why you want to make a lot of money. Is it to quit your day job and start your own business? To pay for a wedding or a child’s education? To retire by age 50 and road-trip around the country?
Next, think about how much money you need to make these wants a reality and when you need to achieve them.
Figuring Out Your Time Horizon
This “when” piece, called your time horizon, is crucial for a successful investment strategy.
The shorter an investor’s time horizon, the more conservative their investment plan and allocations need to be. If you’re nearing retirement age, you want to minimize the risk of losing the wealth you’ve already amassed. When you have a longer time horizon, there’s more time to bounce back from a loss, so you’re able to chase the greater rewards that come with riskier investment opportunities.
Your time horizon needs to be ingrained into the core of your trading plan. An asset may be a great opportunity, but the timing could be all wrong. Instead of looking at investments as clear-cut “good” and “bad,” you need to understand investment opportunities in the context of the time over which you’re able to accrue money toward this goal. Whether you need the money in three years or 30 years matters when you’re figuring out the best way to grow it.
Gauging Your Risk Tolerance
How much are you willing to risk in your investments? The amount of risk you should tolerate hinges on personal and financial factors, including your goals, your capital and your comfort level.
Do you tend to stress over things you can’t control and get hung up on a loss? Or are you able to go with the flow and shake off a minor setback with ease? If you fit in the former category, tolerating too much risk may be bad for your mental health, even if it fits your financial situation. A more conservative approach to investing may not yield gains as strong as a riskier strategy would, but the peace of mind might be worth the tradeoff.
If you’re naturally comfortable taking some risks, your personal risk tolerance may not be as big of a factor. The financial factors, like your time horizon, may require a more conservative investment strategy than you would embrace based on your personal temperament.
Mistake #2: Basing investment Decisions on Current Performance, Not Strategic Projections
When it’s time to choose an investment opportunity, how do you tell the good from the bad? If your approach is to look at how a stock or other asset is currently performing, you could be making a big mistake.
A Cycle of Highs and Lows
Performance in financial investment markets is cyclical. A stock or company that has performed well for a few years may seem like a safe bet, but past performance doesn’t always equate to future performance.
That stock that has seen such steady price rises over the past few years may be about to dip into the beginning of a downward spiral. Buying now could mean buying high and ultimately selling low — the opposite of what you want to do.
There’s No Room for Blind Faith in Financial Investing
You’ll find no shortage of financial investment advice floating around the Internet, television and financial self-help books. The thing is, just because you heard that something is a good investment doesn’t mean it is a good investment.
If you’re blindly following rumors, the “tips” and “hacks” of finance gurus, and the crowd, there’s a good chance you’re basing your financial moves on misinformation. Do just as much research on an investment opportunity shared with you by another source as you would if you’d stumbled upon the opportunity on your own.
How Not to Choose Investments
If you don’t want to chase unlikely returns and end up buying assets at their most expensive, you might think bargain-hunting is a better choice. Conventional wisdom tells you to buy low and sell high, right?
While that’s generally true, the reason why a stock’s share price is low matters. Often, the same factors that depress an asset’s share price to make it such a “good buy” will also keep the price low for the foreseeable future.
Buying penny stocks may seem like it’s low risk, because you’re spending so little per share, but there’s an opportunity cost. These stocks are more likely to remain low than to surge high enough for a good return. In the meantime, you’re missing out on opportunities that could better help your money grow.
If data suggest that a low-priced stock is an up-and-coming contender with plenty of growth potential, buying low to sell high is a great plan – but it takes a lot more than your gut instinct or what sounds like common sense to make this determination.
What to Look at Instead
Investing isn’t as passive a way of making money as you might think. You’re not clocking in hours of labor, but you still need to do your homework. If you aren’t doing the relevant research before you buy or trade assets, you’re making a big mistake.
Start by looking at the quantitative data surrounding an investment opportunity. This includes numerical figures like the share price, volume, moving averages, relative performance in the market and the sales and earnings a company achieves.
You also need to look at qualitative factors, not just quantitative ones. Make sure you understand precisely how a company you’re investing in makes money — often, it’s through different channels — and how it intends to grow.
Spend some time looking deeper into industry and consumer trends to better understand the forces that could affect your investment prospects. Are there trends, new technologies or changes in the consumer market that could pose a big threat to the company (as digital camera technology did to film companies)? Or do industry and consumer trends point instead to the potential for growth?
All of these different factors combined can help you look at projections of a company’s growth, which is what really maximizes your return.
Mistake #3: Focusing on Individual Stocks Over Asset Allocation
Picking and choosing individual stocks is a gamble, not an investment strategy. You’re guessing at winners and losers in the market. No matter how much research you’re doing, there’s always a risk of loss.
That’s why it’s better to emphasize asset allocation and to distribute your investments across the market using bundles of stocks known as index funds.
The Problems With Buying Individual Stocks
When you’re focusing on individual stocks, it’s hard to make an objective decision based on the data. It’s easy for well-intentioned qualitative research — paying attention to a brand’s recognizability or a product’s consumer draw — to cross the line into confirmation bias. Instead of remaining objective, you subjectively believe that, because you personally like the company, it’s a good investment opportunity.
You can offset this human tendency to view data subjectively by doing more research. But drilling down to the details needed to thoroughly research every individual stock takes a ton of time. The result is that many investors who buy individual stocks aren’t doing their homework.
Investors who make a habit of purchasing individual stocks also tend to buy and sell assets quickly. There’s always a newer, shinier, more exciting opportunity just around the corner, and you don’t want to miss out on the next big break. So you sell the shares of the last individual stock you purchased so you can buy shares of the next — and on and on.
You’re not giving the money you invest enough time to grow. Worse, you’re losing money by racking up more transaction fees than you would by sticking to a stable, long-term strategy.
There’s an easier way: focus on asset allocation more generally, rather than filling up your portfolio with shares of individual stocks.
What Is Asset Allocation?
Asset allocation means looking at the big picture of your portfolio and determining how much of your capital should go into different types of assets. Investing 100 percent of your capital in individual stocks is risky. In asset allocation, you would first decide what proportion of your money should go into stocks.
If you have a high tolerance for risk and a long time horizon, you might allocate 80 percent of your capital to stocks, one of the riskiest types of investments. You might split the remaining 20 percent of your capital between fixed-income securities and cash and equivalents. These investments tend to see slower, steadier growth. They’re less likely to lose money, but you don’t have the same potential for gains with them as you do with stocks.
Someone with a short time horizon or a strong aversion to risk may flip around these allocations. Slow-growing investments in securities and in cash and equivalents may make up 75 percent of your portfolio or more. You would invest the remaining proportion of your capital — what you’re prepared to potentially lose — in riskier asset types like stocks.
Investors who focus on asset allocation, not individual stocks, are looking at the big picture. They don’t get bogged down with the minuscule details of every stock. They’re less likely to be swayed by a risky individual stock — and if they are, that one minor misstep won’t derail their trading plan.
Bundling Stocks With Index Funds
Once you’ve decided how much capital you’re going to allocate to stocks, you need to pick which stocks to invest in. Dwelling on individual stocks still isn’t your best option. Instead, you can invest in an index fund, which bundles together stocks across the market.
Bundling your stocks reduces your risk of loss. Even if a stock declines in performance, you’re not invested only in that one stock, but in a collection of separate stocks. You can bounce back much better from the underperformance of one stock out of many than from a drop of one of a small number of hand-picked stocks.
Mistake #4: Being Unrealistic about Risk
Risk is part of investing. But so is managing risk. Before you can worry about how to financially manage risk and reduce your losses, you need to develop a realistic expectation of how risk will fit into your life as an investor. This is harder than it sounds.
The Certainty of Risk
Thinking about your financial and personal risk tolerance early on while developing your trading strategy is just one part of developing a healthy, realistic view of how risk plays into investing.
No investor wants to lose money. But pretty much all investors will see some amount of loss at some time. Dips are part of normal market fluctuations.
The good news is that these declines typically even out in the long term. Despite drops here and there, investors who enter the market with a strategy and stick with it over time make a lot more money than they lose.
The Unrealistic Risk Ideas New Investors Have
When you first begin investing, you’re likely to confront some surprising ideas you have about risk and your own vulnerability to it. Some of the unrealistic ideas new investors may uncover about financial risk include:
- Expecting that you will never lose money while investing
- Feeling disappointed if you don’t see immediate, consistent gains
- Anticipating making a lot more money in a much shorter time than is feasible
- Getting overconfident, especially if your initial investment moves pay off unusually well
- Expecting results that don’t match your portfolio — such as being too conservative to see the gains you want or too aggressive to avoid excessive losses
New investors may struggle with developing a practical understanding of risk, even if they understand it in an abstract way. They know loss happens but still get spooked when it happens to them.
Crafting your investment strategy around your risk tolerance is a great place to start, but if you don’t reconcile your feelings about risk, you’re likely to abandon that plan. Without a balanced, healthy view of risk, new investors may quickly lose confidence in their strategically chosen investments — or in the financial market and investment systems as a whole. This may lead you to do exactly the opposite of what you want to do in investing: completely pull out of the market at a loss, reducing your ability to bounce back from the decline.
Although you don’t have to — and shouldn’t — stay in a bad investment scenario, giving up completely and pulling what’s left of your money out of the market is rarely the right solution.
Mistake #5: Failing to Diversify Your Portfolio
One crucial way to manage risk is by diversifying your portfolio. This means you don’t want all of your investment capital in one type of asset — like stocks, bonds and cash.
Diversifying Your Portfolio Beyond Asset Allocation
If you’re paying attention to asset allocation, you’ll naturally avoid having all of your investment capital in a single type of asset. There’s a difference, though, between spreading out your investment money over different types of assets and having a fully diversified portfolio.
Take stocks, for example. Some amount of investment in stocks or equities is typical for most investors, even those with a conservative portfolio. Within this asset category of stocks, you’re going to want to invest in a diverse collection of industries and companies.
You don’t, for example, want to invest only in tech startups, because these ventures are risky. For every famous tech startup you can name, there are many more that never took off or that quickly fell out of favor.
Similarly, you don’t want to invest all of your money in a narrow industry, where one event could wipe out a bunch of major players. If you invest entirely or primarily in oil and gas companies, a natural disaster that strikes one of the world’s largest petroleum deposits could cause all of your stocks to plunge at once. That’s a big problem if stocks make up the majority of your portfolio.
Truly diversifying your portfolio means avoiding having too many of one type of asset and too many assets in one industry.
Owning a Balanced Number of Stocks
You can’t diversify your portfolio until you invest in enough assets. If you decide to dip your toes into the waters of financial investing by buying one or two stocks, then your portfolio isn’t going to be diverse.
Owning too few stocks raises your risk of loss. With just two stocks, a sharp decline of one stock can obliterate half of your investment capital. The impact is a lot less if it’s one out of 10 stocks, or 20, or 50.
Investing in a balanced number of stocks is a good goal for a beginner investor. You ultimately want to have enough stocks that no one investment puts you heavily at risk of a serious loss. There’s no perfect number of stocks to buy. What’s more important is finding a balance that works for you. Ultimately, you should strive to fine-tune your portfolio allocation so that you’re seeing reasonable returns and a manageable level of risk.
Mistake #6: Neglecting to Rebalance Your Portfolio
A diverse portfolio isn’t a “set it and forget it” thing. Smart investing means evaluating and strategically adjusting your investments on a regular basis. You want to make sure your portfolio stays balanced and diversified even as markets change.
Rebalancing your portfolio requires revisiting how your asset allocations compare to your investment strategy and overarching financial goals. If your portfolio and your plans are out of alignment, bring them closer together by trading assets or tweaking your investment plan to reflect your updated goals.
The Discipline to Make Long-Term Choices
What distinguishes an experienced investor from a beginner is understanding the value of balance.
Selling all of your poorly performing stocks to buy more of your best-performing stocks may seem like a no-brainer, but in reality, you’re exchanging a smart long-term strategy for risky short-term gains. Investment markets are too dynamic to sink all of your capital into a handful of assets. No matter how well these stocks may be performing now, trends will eventually shift. In an unbalanced portfolio, the losses that result from this shift could be even more drastic than the gains you enjoyed during the stock’s heyday.
If you let one company, industry or asset type become overrepresented in your investments, rebalancing your portfolio may look like trading some high-performing assets for less stellar ones. It’s painful at the moment but, like a bitter-tasting medicine, it’s good for you in the long run. Remember, the reason you want a diversified portfolio is to minimize the risk so you can better achieve your long-term goals, even if you wind up making less in the short term.
What Else to Review When Rebalancing Your Portfolio
A savvy investor does regular research into the gains they’re getting. Although you don’t need to be aware of every single rise and fall of the stock market, you should periodically review the performance of your stocks as well as the financial projections and growth strategies of the companies in which you’ve invested.
What are you doing with the money you’re making? If you don’t need it for a short-term goal, reinvesting your gains can make the most of your investments and really add up over time.
Suppose you invested $10,000 and saw a 10 percent return rate in the first year (that’s the historical average rate for the S&P 500 index). Congratulations — you made $1,000!
If you reinvest that $1,000 and see the same rate of returns next year, you’ve added an additional $100 to your gains that you wouldn’t have gotten if you withdrew that $1,000 from the market. That’s far more than you’d make in interest in a traditional savings account.
By the end of the fifth year, your $10,000 has grown to more than $16,000 — and that’s if you chose not to invest any more money besides the gains you made on your initial investment. Of course, because of normal market fluctuations, you won’t see the exact same rate of return every year on your investments. The point is, making capital gains on your capital gains can magnify your investment income results.
Mistake #7: Accumulating Excessive Losses Without a Plan
Losses are a normal part of investing but still something you want to minimize. Having a plan can help you avoid excessive losses and bounce back quicker from moderate losses.
Deciding How Much Loss Is Too Much
Can you recognize a downward spiral early enough to cut your losses? Most investment newbies can’t.
While you don’t want to jump ship at every minor downturn, you also shouldn’t hold onto a losing asset as it keeps plummeting, taking your capital down with it. Your investment strategy should include preparation to take action, without hesitation, when you’re at your breaking point.
The first step is determining what that breaking point is. If you set a threshold for the maximum losses you’re comfortable sustaining from the get-go, you won’t find yourself basing your strategy regarding losses on feelings and intuition instead of sound mathematical data.
As you review losses, you can remind yourself that some amount of loss is normal and that the amount of loss you’re seeing is still in the acceptable range. And, once your losses are no longer within that acceptable range, you know that it’s time to get out of that investment before it plummets any further.
Missing Out on the Security of Automated Stop-Loss Orders
Wouldn’t it be great if there was some way to make sure you never go over the maximum level of loss you’re comfortable sustaining? There is — but most beginner investors don’t know about it.
This solution is called a stop-loss order. It’s an automated command that you can set in place to protect you from a big loss.
You decide the parameters and “set it and forget it” – for now. It’s always a good idea, as you regularly rebalance your investment portfolio, to also revisit your current risk tolerance and the time horizons of your investment goals. If the threshold of how much loss you’re able to sustain has changed, you can adjust your stop-loss order.
Mistake #8: Trading Too Fast or Too Often
Investing is a long-term moneymaker, not a get-rich-quick scheme. If you don’t come into it with realistic expectations, you’re likely to get impatient with the results you’re seeing — or freak out over normal dips — and make the mistake of trading stocks and assets too quickly.
Why Trading Too Fast Is a Mistake
How quickly you buy and sell stocks matters because you may not be sticking with your investment long enough for it to really grow. You may end up selling your existing stocks at a slight loss to free up your capital for the next opportunity — which, when repeated over time, adds up to much bigger losses.
Frequent traders also spend more in fees than investors who follow a steady long-term plan. There’s also a tax burden investors should be aware of. The money you make in the stock market can be taxed, but long-term gains are typically taxed at lower rates than short-term gains, or gains from assets you have held for less than a year. Even if you see the same gains with your frequent trades as you would by holding onto your assets longer, you’re keeping less of the money you make due to the difference in tax rates.
The Dangers of Day Trading
One particularly risky practice is day trading, when you buy and sell an asset on the same day. You need to have perfect timing as a day trader, because stock prices fluctuate quickly. You also need technology that’s fast enough to keep up with you, because even a brief moment of lag time can mean selling your stock at a loss.
Day trading is so risky that the U.S. Securities and Exchange Commission warned consumers that day traders should “be prepared to suffer severe financial losses.”
If you’re trading assets quickly, your moves probably aren’t being guided by a smart investment strategy, but instead by an impulsive need to see short-term results.
Mistake #9: Letting Your Emotions Drive Your Investing Moves
Are investment gains and losses just money, or something more? You’d be surprised how often emotions cloud an investor’s judgment — especially for a new investor.
Getting All the Feels From Your Financial Investments
Greed, fear and even euphoria can be part of investing. Part of transitioning from a beginner investor to an experienced investor is learning to manage these emotions without letting them take over your strategy.
If you find yourself eyeing stocks with climbing share prices and obsessing over buying them, greed could be what’s motivating your investments. While you obviously want to make money on your investment, greed often has you chasing unrealistic short-term gains. When you do achieve short-term gains, the sense of euphoria can drive you to invest more money than is smart (including borrowed funds), take bigger risks than planned and lose touch with that realistic expectation of risk you worked so hard to develop.
What precipitates impulsive selling is usually fear. Many new investors panic when they see normal losses and give up their well-reasoned trading plan. Instead of holding steady while the amount of loss is within the parameters they’ve established as acceptable, they backtrack and pull their money out of the market.
Poor Investment Decisions That Appeal to Our Emotions
If you’ve ever sunk money into a hobby or collection because “it will be worth something someday,” you’ve probably fallen prey to the emotional appeal of alternative investments. Baseball cards, comics, coins, stamps, TY beanie babies (with the tags on) — the list is endless.
These alternative “investments” are unlikely to get you results. Although you occasionally hear about the rare baseball card that sold for $1 million, that’s the exception. All that most collectors get out of their hobby is the joy that collecting these items brings to them. By all means, collect something that you enjoy, but don’t do it with the intent of profiting financially.
Likewise, you shouldn’t treat your home as a replacement for investment savings. Anyone who has ever sold a home has likely learned the hard way that your subjective view of your home’s value doesn’t always match an objective appraisal. Using your home as an investment — in place of retirement savings — makes a lot less financial sense than it does emotional sense.
That’s not to suggest owning a home is a waste of money. But classing your home as an investment may lead to developing unrealistic expectations of its worth and the return on “improvements” such as remodeling. Your home is a place where you live that may end up adding some long-term value to your financial situation, not a substitution for real financial investing.
Even stocks can trick you into making an emotional investment. Suppose you invest in an individual stock that belongs to a company you admire and buy from often. Maybe that stock performs well at first, which cements your loyalty to the brand. Even once it hits a downswing, you don’t want to believe your stock is on the decline. Your emotional investment in the brand has influenced your perception of the stock’s financial performance and complicated your strategic investment decisions. But it’s still just an asset that’s supposed to be making you money.
What should you do if you catch yourself letting emotions drive your investment moves? You can reevaluate how you choose your investments. Some investors establish data-backed thresholds of criteria an investment opportunity must meet for them to consider it.
It also may be time to revisit your trading plan and spend some time thinking about realistic expectations of risk and about whether you’re mentally ready for investing. There’s no shame if you’re not! You may just need to take a more introspective look at your feelings and fears about finance and risk before you’re ready to take your investing game to the next level.
Mistake #10: Letting Your Ego Get in the Way of Cutting Your Losses
Does anyone really want to be wrong?
In investments, as in so many areas of life, admitting that you were wrong is a discouraging prospect — but it’s still a lot better than clinging to a bad decision just to spare your pride.
At the end of the day, investing isn’t about “winning,” it’s about capital. Your pride won’t keep a roof over your head and food on your table after you retire. Your investment gains will.
Tricking Yourself Into Thinking a Bad Investment Is a Good One
Some investors don’t want to be wrong so much that they twist the numbers to make their investment look more successful than it really is. They might, for example, try to judge success based on how much a stock’s share price has dropped from its 52-week high instead of judging based on actual returns.
This data may make you feel better about the investment, but it’s a hollow reassurance. You’re not seeing any actual increases in wealth.
So go ahead, acknowledge your mistakes and bad investment decisions — everyone makes them — and move on to avoid sustaining any more losses. Who cares if you were wrong about an investment, as long as you end up with positive returns over the length of your investment plan?