Improper Investment Allocation
One of the biggest mistakes people make when investing is incorrectly allocating the funds they have available. This is usually made when people have lump sums of money at one time.
These lump sums, whether from an inheritance, bonus, or even severance packages, can leave you with a large stack of investment capital with which to work.
Rather than putting all of the available money in one place, it is prudent to distribute the funds you have available.
Instead of going into one category, allocate the money you have available over five or six different investment opportunities.
This formula will help you account for your risk tolerance and financial long-term goals.
If you have one or two "pots" available, a portion should go into an index-based mutual fund and the rest should go into high quality bonds.
If you have three or four pots, an even portion of your money should go into the index fund, bonds, stocks and any other investments within your range of risk tolerance.
If you have five or six pots of available money, half of your funds should go into bonds and the balance should be split evenly between an index fund, stocks, and other investments like real estate, business, etc.
Emotional Investment Behavior
When starting out, it’s easy to become an emotional investor.
We might follow the progress of certain stocks and feel worried, anxious, or elated every time we read the news. We may follow the behaviour of others and just buy whatever they have recommended that week.
These types of investors are constantly changing their portfolio, and this can end up costing them money.
We call these investors active investors, and they make up for the majority of the investment community. About 70% of the people that start investing have a tendency towards typical investing behavior.
If you want to become a successful investor, you need to make sure that you don’t fall into this category. Of course, it’s useful to have a balanced portfolio that contains a number of different holdings. But it’s useless if you don’t stick to your guns and follow through with your strategy.
Here’s the REAL problem with trying to beat the market… it’s a fact that the majority of investors will try something and then give up.
All those stock tips you hear about? Well, they are popular because they are fun to hear and easy to understand. Everyone likes to have a good laugh about the latest investment tip they heard from a colleague.
I was once taught that if an investment doesn't cost anything then it's not worth the time to research and find if it's right for you. While this may be true, be very careful. Anytime you are pressured to make a rushed decision, and it doesn't take any time to talk about things, then something is wrong.
Most investments of all kinds have fees and commissions built in, you just don't see them because they are calculated differently. Instead, you are given the choice of paying a set amount at the beginning of the year. The problem with this is that you may not be getting the full picture. Of course if you are putting in more than you are getting out, the fees are starting to add up and you may be giving up returns that you didn't even know existed.
With investments, there is always a certain amount of risk involved, so make sure you know about all the fees and commissions going in.
People who have never traded before think that trading is about making bets and just knowing when to buy and when to sell. In reality, trading is a science. You have to know why you made a decision, and you have to be able to predict what will happen after you make the decision.
If you’re making the decision just based on what your gut tells you or what an expert’s prediction is, you are not trading. You are speculating, but you’ll have better luck if you play the lottery than if you speculate in stock.
Let’s take a look at a previous post that Shaibi made about the Rule of 100.
When new traders start looking at the stock market, the first instinct tends to be to buy any stock that seems to be moving upward on the chart. Unfortunately, this creates a lot of buying pressure as the stock rises to the top, and even more selling pressure as it starts to fall. This is why many new traders have a hard time keeping their winners.
For every stock or index you have on your trading portfolio, you can draw a line that covers the entire 7-year chart, dividing the chart length into two equal halves, and draw a second line in the middle.
This is a basic example:
Failing to Diversify
It's become a modern day mantra that you shouldn't put all of your eggs in one basket. The same is true of your investment portfolio. If your portfolio is made up of 100% blue-chip stocks, you can be pretty confident that your portfolio, as a whole, will grow over the next ten years. But you can certainly be blown out by factors affecting specific stocks, industries, or sectors.
Diversification is all about reducing your risk. If you mix and match different asset classes … stocks, bonds, cash, real estate, commodities, etc. … you're reducing your exposure to one specific area negatively affecting your portfolio.
Portfolio diversification is meant to help smooth out your investment results. Instead of winning big on one trade, and losing a bunch on another, you give yourself a better chance of finishing in the black.
Many experts recommend having some amount of bonds in your portfolio. And it's generally a good idea to have a portion of your portfolio in international markets. If you're interested in getting started, there are plenty of online services that can point you in the right direction, including Vanguard, Schwab, and even your local bank.
Getting Wrong Investment Advice
It is natural to think that taking a quick and easy way out will lead to quicker and easier money. And it's not that easy to blame anyone for thinking so.
Everyone, including experts, speculate and make educated guesses. And it's true that short-term success is possible with high risk and high reward ventures, but those are not for everyone. Indeed, guaranteed large profits are rare.
A vote of confidence, and the sense of certainty it gives, can be intoxicating, especially if you are a novice in the game. But be careful; the person you are getting advice from may not have your best interest at heart and may not even know his own limitations. So learn to listen, research, and then act.
It is better to take your time and spend a few weeks or months doing your homework and studying, than to take a plunge only to lose everything, which is exactly what you are likely to do if you get wrong advice.
Buying Investments You “Love”
You probably have some favorite investments that you know like the back of your hand.
Why is it dangerous to love a stock or investment? Because love is blind, and when you fall in love with a common stock, company, or asset, you may pay too high a price. You may even ignore the risks. Love may make you rush into a bad investment, and then you will owe it to yourself to look at love objectively. You should find a way to understand why you love it, and you will need to weigh its true value.
The stock may have some nice qualities, but that doesn’t mean you would or should buy. Look objectively at the risks and the market. You can do this if you want to love it enough to buy, or if you want to love it by selling and moving on.
Not Analyzing a Company’s Financial Statements
Although you may not be a seasoned financial analyst, you should spend some time digging into a company’s financial statements each time you invest in a new company. It’s easy to get caught up in everything else that you are evaluating about a company but it’s important to remember that the most important thing is always the numbers.
There may be a flashy product and a charismatic CEO getting all the headlines but none of that really matters if there’s not a profitable business underneath.
Getting caught up in the hype and flooding your inbox with alerts on the latest “must have” company is easy to do. But it’s a dangerous path to go down if you don’t take the time to review the company’s financial statements.
It should go without saying but the fundamentals don’t change. A big product launch or flashy acquisition can be a short-term driver of stock prices but it will not make a company profitable in the long-term.
Even with some of the best execution in the world, a profitability problem will eventually poison a company’s profitability so paying attention to the numbers is a worthwhile strategy.
Underestimating Risk Exposure
How much risk are you prepared to take to become a wealthy investor? It is very important to set this to make it easier for you to know about your own personal limits.
Most investors enjoy what they are doing because it is a type of gambling. You are trying to win a big thing out of it.
Everyone likes the idea of getting rich quick. It is one of the reasons why investing in penny stocks, options, and other financial instruments by independent sellers is becoming a more popular approach. The risk becomes higher because you don’t have the same type of protection as you would get from buying stocks or options through a reliable broker.
You need to put the effort in understanding your limits and you should also be prepared to take losses, especially when you are trying a type of investment that you have not tried before.
You don’t want to invest everything in a risky venture, and then watch your life’s savings disappear during the first ten months of investing.
Ignoring SEC Filings and Prospectus
If you’re thinking about getting into the investing arena, you’re probably aware that the SEC and FINRA researchers that they hold companies to a certain level of transparency, especially when it comes to prospectus writing.
SEC filings tell potential stockholders the information they need for an informed decision as far as the company’s finances are concerned. Prospectuses tell them what they need to know about the risks of investing in a particular company.
Ignoring SEC financial statements is a huge mistake. Not only will you miss important information that will help you along the way, you’ll have no defense if there are any problems.
Don’t ignore the risks. Be informed about the potential cost if things go wrong.