Nov. 9, 2020
This article originally appears on The Motley Fool, written by Christy Bieber.
Investing is key to building wealth, but you could undermine your efforts if you make some common errors. Recent research from the Natixis Global Survey of Financial Professionals identified the eight biggest investment mistakes financial professionals believe are the costliest errors you can make. Here’s what they are.
1. Panic selling
A whopping 93% of financial professionals identified panic selling as a top investing mistake, and with good reason. When you see your investment account balance start to fall or the economy starts to look shaky, it’s hard not to make bad decisions based on the fear of losing everything. Unfortunately, selling when the going gets rough is a surefire recipe for disaster. It means you’ll always end up selling low and missing out on the recovery that almost inevitably follows any market correction.
The good news is that this error is easy to avoid if you have a solid investment strategy. If you’re confident in your investments, you can step away from your portfolio during downturns to avoid the temptation to sell. Or, you can make the smart play and invest more money and take Warren Buffett’s advice to be greedy when others are fearful.
2. Trying to time the market
On the surface, aiming to buy stocks when share prices hit rock bottom and to sell when they’re at their peak seems like a good strategy. The problem is that most people can’t predict exactly when share prices will hit their optimum point. And missing even just a few good days in the market due to poor timing could leave you hundreds of thousands of dollars poorer.
That’s why it’s not surprising that 50% of financial professionals list market timing as a top mistake. This is also easy to avoid, though. Dollar cost averaging, or buying shares on a regular schedule over time, eliminates the need to determine the perfect moment to buy shares.
3. Failing to understand your risk tolerance
There’s generally an inverse relationship between risk and potential reward, where the riskier the investment, the greater the potential returns. Unfortunately, 45% of financial professionals indicate that a failure to understand risk tolerance is a top mistake investors make.
You need to make a calculated, informed choice about how much risk you’re willing to take in order to decide how much money to put into stocks (which are riskier but present an opportunity for higher returns), as well as whether to invest in index funds (the safer bet) or individual stocks (which provide a chance to beat the market).
Risk tolerance is something that should change over time. Before you start seriously investing, think about how comfortable you are taking chances with your money and let this guide your investing strategy.
4. Having unrealistic expectations of returns
It’s important to make reasonable projections about how much your investments will earn. If you expect a 20% average annual return, you may think you need to invest a lot less than if you expect 2% average annual returns.
Unfortunately, 43% of financial professionals indicate that unrealistic expectations of returns is a major mistake investors are making. To avoid this, look at the historical performance of investments you’re considering, and study the fundamentals of any stock you plan to buy to assess its realistic potential.
5. Taking too much risk in pursuit of yield
While many investors misunderstand their own risk tolerance, others take on too much risk and gamble with their futures. That’s why 25% of financial professionals identify taking on too much risk as a costly investment mistake.
If you invest in high-risk investments or put too much of your money into the market, you stand the chance of facing outsized losses if things go wrong. Instead, make sure your asset allocation and risk exposure are appropriate to your age and objectives. If you’re saving for retirement, for example, subtract your age from 110 to determine what percent of your portfolio should be in the stock market.
6. Failing to recognize the euphoria of an up market
This is the opposite of panic selling, and 25% of financial professionals indicate it’s also a very costly error.
When investors get too excited that things seem on the upswing, this leads to asset values escalating without justification. You could easily end up buying in a bubble and getting stuck with a portfolio full of overvalued stocks. The good news, however, is that dollar cost averaging and a sound investment strategy focused on the fundamentals of each company can help you avoid this error too.
7. Focusing on cost rather than value
Far too many investors focus too much on share price at the expense of considering what shares are actually worth.
This often leads to an inaccurate belief that stocks under $5 are a “bargain,” even if the companies are unproven or haven’t published much financial information. It could also lead inexperienced investors to assume stocks with a high share price are worth their cost just because of their high price tag. These types of errors are likely why 19% of financial professionals identify a focus on cost rather than value as an expensive mistake.
The reality is that a stock that costs $5,000 per share is a better value than one that costs $10 if the first is likely to double and the second will most likely lose half its value. The key is to look at the company’s past performance, leadership team, competitive advantage, and potential for growth when deciding which is a better buy.
8. Failing to consider the tax implications of investment choices
Finally, 9% of financial professionals indicate that a failure to consider the tax implications of their investments is a costly error people are making.
This can be a problem if, for example, investors miss out on the chance to take advantage of favorable long-term capital gains rates, or if they don’t engage in strategic tax-saving moves such as tax loss harvesting. Understanding the tax rules that apply to investment income is a good way to avoid this error.