How to avoid the most common new-investor missteps.
Today on MoneyGirl, we will take a look at the seven most common mistakes investors make and the lessons that we can be learn from them.
Several listeners have written in and asked how to avoid the most common new-investor missteps.
What am I talking about? Think back for a second…Have you ever found yourself saying: That was so stupid, I should have known better. Or, why did I sell that stock? Or even, why did I listen to Uncle Irv’s stock tip?
AND, do you have that condition I call Red-Forehead-Syndrome? You know, when you bang your head on the desk over and over because you feel you made a stupid mistake when investing.
Do doo da dooo! Help has arrived!
Believe it or not, even Warren Buffet has made a mistake or two during his illustrious 40-plus years of investing. So, you should expect to make some mistakes yourself. The trick is to recognize your mistakes and learn from them.
Mistake Number 1 – Using Too Much Margin
Margin, or borrowing to leverage your investments, is known in investment circles as "free money." But the truth is, many times it is exactly the opposite. If you use too much borrowed money, and your margined- investments start losing, your losses will be compounded. Remember, eventually you will have to pay back the money that was borrowed and if you didn’t use margin wisely, you can really be in for some financial pain. If you use margin without discipline, you might as well just throw your money out a window--you will get the same result. The lesson to be learned is simple. As a new investor, use margin sparingly, if at all. Wait until you are more experienced and more aware of the pitfalls of investing on margin.
Mistake Number 2 – Buying Stocks On Unsubstantiated Tips
This is the mistake played out so well on sitcoms, comedy routines, and with your crazy Uncle Larry who tells you that he is "quite sure this is the next hot stock.” Taking a tip in itself is not a huge mistake, but not following up on these "tips" with thorough research and not considering the source can be the biggest financial faux pas you will ever make. Just because you got the tip from your crazy Uncle Larry, who is back on his winning streak,ever since he got back from the “pen” may not be a great long-term strategy. The lesson to be learned – Thoroughly research any "hot tips" and try to get a second opinion before investing your hard-earned money.
Mistake Number 3 – Day Trading
As alluring and flashy as day trading appears to the inexperienced outsider, day trading for a novice investor is nothing short of money-masochism. You have surely heard about investors who spend all day in front of the computer buying and selling stocks. You have also heard the stories of day traders making thousands on one trade before their first cup of coffee in the morning. But, did you know these investors also started small? They worked their way up to the bigger profits …and losses. In order to be successful, they need a good amount of data, research, and a well-heeled strategy to make a consistent profit. As a day trader, you need training, patience, and most importantly – discretionary capital. Without these and specialized trading software, you can lose and lose fast. The lesson to be learned – If you are not particularly skilled at dealing with stress, there are other options other than day trading to help build your wealth. Look at day trading as a career, not a hobby or sideline.
Mistake Number 4 – Overestimating Your Abilities
This is the probably the worst mistake the new investor can make. Overestimating your abilities as an investor is usually the product of early success. Often times, when you begin managing investments, you can get swept up in the euphoria and start drinking in your own success. Overconfidence while investing is the trait of a rank amateur--the amateur who eventually wonders why his early success has turned into massive failure. Sure, If you invest your time wisely in research and strategy, you can do well, but you need to always be on the lookout for your next landmine. Always ask, what am I missing, what can go wrong?
The lesson to be learned – Do not assume that simply because you have a computer and the Internet that you can beat the pros. Red and green buy and sell strategies may get you a profit here or there, but investing requires patience and above all, a touch of humility.
Mistake Number 5 – Forgetting to Look At the Big Picture
Even after studying all of the technical jargon – financial statements and predictions – many new investors forget to look at the rest of the picture – the economy and the trend. The pros say: “The trend is your friend” and “Don’t fight the tape.” Sometimes we get caught up in the minutia and forget to look around at what is right in front of us. Remember, investing in bad stock in good times may produce profits, but investing in a good stock in bad times will often produce losses. Step back and look at things from a distance to gain perspective.
The lesson to be learned – Looking at the big picture is just as important as being technically savvy and fundamentally correct. If the wave is big enough it will knock down even the biggest building. The same is true with the markets. Remember, a rising tide raises all ships.
Mistake Number 6 – Compounding Your Losses With Pride
Many investors spend days, and even weeks, before choosing to invest in that perfect stock. But what happens when the stock goes south? Well, many novice investors let their pride get in the way and they choose to keep the stock. William O’Neill teaches that stocks should be sold once they are 7% lower than your purchase cost. No ifs, ands or buts.
The lesson to be learned – No matter how much time you spend researching a stock before you invest , always have a sell discipline. Make sure you are following a plan to ensure that your downside risk is tolerable. Take pride and emotions and leave them at the door, there is no room for either of those in a profitable portfolio.
Mistake Number 7 – Beware the Bargain Stock
Sometimes a stock is low because it is supposed to be. Sure there are times when a stock is mispriced, but not often. There may be reasons that you are not aware of that the price has crashed 50%. Even if everything looks good, something may be awry. In many cases, there may be a fundamental reason for the decrease in price that will revel itself sometime in the future.
Lesson to be learned – Price alone should not be the determining factor in making a decision of whether a stock should be purchased. Do your homework.
For more information about getting started in investing check out The Winning Investor's episode for starting out as an investor and Money Girl's episode of investment strategies. You can also refer to Money Girl's Quick Tip on insuring your investments.
Cha-Ching …and that’s all for now. Courtesy of Andrew Horowitz, guest host of Money Girl’s Tips for a Richer Life. Thanks for tuning in to “Money Girl”. And to thank Darren, Katie and Shannon for sending in questions that helped with this important show topic, we are going to send you a copy of my book.
Remember, these disciplines are just a few that I cover in my Book – The Disciplined Investor – Essential Strategies for Success. Pick up a copy at Amazon and start on the road to becoming a disciplined investor.
As always, everyone’s situation is different, so be sure to consult a tax or financial advisor before making important financial decisions. This podcast is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice.
Thanks for listening!
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