When it comes to investing, there are many ways to lose money. But there are also some tried and true methods to avoid making dumb mistakes.
First, don’t buy into the hype. Just because everyone talks about a hot new stock doesn’t mean you should buy it.
Second, put only some of your eggs in one basket. Diversify your investments to mitigate risk.
Third, do your homework.
When it comes to finances and investments, even intelligent people can make blunder after blunder. I believe that most individuals simply do not have enough time in their schedules to educate themselves on the topics essential for sound decision-making.
Another reason is that when you do something stupid, it almost always results in the financial gain of another party, such as a salesperson for an investment product. Sound financial decisions can save you money and headaches.
Don’t Forget To Diversify
The return on the stock market is often around 10 percent, but to earn 10 percent, you must have a diversified portfolio of equities. Expand your horizons.
It is incredible how many people do not diversify their investments, although it is evident to anyone who gives it more than a few minutes of thought that it is true. For instance, some people own significant portions of their employer’s shares but tiny else in their portfolios. Or they have a few different equities related to the same sector.
You need approximately 15 to 20 stocks to span various industries to generate profits from the stock market. (I did not develop these numbers independently; the range of 15 to 20 is derived from a statistical formula explained in several advanced placement and graduate-level finance textbooks.)
If you have less than 10 to 20 stocks in your portfolio, the returns it generates will undoubtedly be either higher or lower than the average returns caused by the stock market. It goes without saying that it doesn’t matter if your portfolio’s return is higher than the stock market’s average return, but it does matter if your portfolio’s return is lower than the stock market’s average return.
By the way, it is only appropriate to let you know that some brilliant people do not agree with my position on keeping 15 to 20 stocks. For instance, Peter Lynch, the incredibly successful former manager of the Fidelity Magellan mutual fund, recommends that individual investors hold between four and six stocks that they have a solid grasp on.
Although Mr. Lynch is far more knowledgeable in selecting stocks than I will ever be, I would want to politely disagree with him for two reasons. To begin, I believe Peter Lynch is one of those humble geniuses who underrate their intellectual capacity. His belief, which he conveys in his books, is that an individual investor can outperform the stock market’s average performance by adhering to this technique.
Second, I believe most individual investors do not have the accounting knowledge necessary to properly use publicly owned corporations’ quarterly and annual financial statements in the methods Mr. Lynch recommends. In other words, he is one of those people. I wonder if he undervalues the profound analytic capabilities he brings to the task of stock selecting.
The stock market and other securities markets experience volatility on a daily, weekly, and even yearly basis, but the long-term trend has consistently been upward. This is true even when accounting for shorter time frames.
Since World War II, -26.5 percent has been the poorest one-year return. In recent times, the worst possible return on investment was 1.2 percent. These numbers are somewhat alarming, but things take a far more favorable appearance when viewed over a more extended time. The worst possible return over a quarter century was 7.9 percent each year.
Patience is a trait that is essential for successful investors to possess. There will be a good number of terrible years. There is a high probability that one bad year will be followed by another awful year.
But as time passes, there are more prosperous years than difficult ones.
People who try to follow every trend or purchase the popular stock in the previous year nearly always fare better than patient investors who remain invested in the market during both good and poor years. They also compensate for the less favorable years.
Continually Put Money Aside
Investing with a dollar-average strategy might be familiar to you. You make purchases of a specified dollar amount at regular intervals, such as $100, rather than acquiring a predetermined number of shares at each interval. If one share costs $10, you will purchase ten of that share. If the price per share is $20, you will buy five shares. You would buy twenty shares at the cost of five dollars a share.
Investing with dollar averages has two distinct advantages. Most importantly, you make consistent investments in strong and down market conditions. If you invest $100 in stocks at the beginning of each month, for example, you should not cease doing so even if the market is experiencing a severe decline and every financial writer in the world is striving to stoke the flames of investor anxiety.
Another benefit of investing using a dollar-average strategy is that it allows investors to purchase a more significant number of shares when prices are low and a lower number of shares when prices are high. Consequently, you won’t let yourself be swept away by a rising wave of optimism and will purchase the majority of the stock while either the market or the stock is rising. When the market or a specific stock is performing poorly, you should not let this discourage you from purchasing shares of that company’s stock.
Participating in a company-sponsored 401(k) or deferred compensation plan makes dollar-average investing easy. This is also one of the most efficient methods. When participating in one of these programs, you invest money whenever money is deducted from your paycheck.
It is necessary to dollar-average each stock to make dollar-average investing work with individual equities. In other words, if you want IBM stock, you must buy a particular number of shares at a given price every month, quarter, or anytime.
Don’t Ignore Investment Expenses
Investment fees can pile up rapidly. Slight variations in expenditure ratios, expensive subscriptions to investment newsletters, online financial services (even Quicken Quotes! ), and income taxes can rapidly reduce your net worth by hundreds of thousands of dollars throughout an investing career.
I’ll illustrate my point with some concrete illustrations in the following sentences. Let’s imagine that you invest some of the money you receive from your 401(k), $7,000 annually, in a couple of mutual funds that mimic the performance of the Standard & Poor’s 500 index.
The expense ratio for one of the funds is 0.25 percent each year, while the other fund’s expense ratio is 1 percent per year. In 35 years, you will have approximately $900,000 invested in the fund, which has an expense ratio of 0.25 percent, and roughly $750,000 invested in the fund, which has a ratio of 1 percent.
Another example: you decide not to subscribe to a $500-per-year specialized financial newsletter and instead invest the money in a tax-deferred account like an individual retirement account (IRA).
Let’s imagine you also put your tax savings into the investment that qualifies for a tax deduction. After 35 years, you will have accumulated approximately $200,000 in wealth. When you consider that you could have invested the same amount of money and collected interest and dividends for several years, investment costs can quickly add up to a significant amount.
Don’t Get Greedy
I wish there was a risk-free way to make fifteen or twenty percent per year. I unequivocally affirm that it is. But, regrettably, that is not the case. Depending on how many decades of data you look at, the typical return of the stock market falls somewhere in the range of 9 to 10 percent. The equities of significantly more hazardous small companies have performed marginally better recently.
They generate annual earnings of approximately 12 to 13 percent on average. You are in luck because returns of 9 percent can lead to financial success. However, no risk-free investment has regularly returned annual gains that are significantly above the long-run averages of the stock market. You simply need to proceed slowly and methodically.
I bring this up for one very straightforward reason: when people let their greed get the best of them and pursue profits that are out of line with the average yearly returns of the stock market, they make all sorts of poor judgments regarding their investments. Refrain from believing someone who claims to have a sure-thing investment or investment technique that pays a certain percentage, such as 15%, if they tell you about it. Additionally, for the love of Pete, do not purchase stocks or seek investment advice from that individual.
Investing is never a guaranteed thing. If someone did have a system that was certain to produce annual returns of, say, 18 percent, that person would quickly become the wealthiest person in the world. That consistent return from year to year would allow the person to manage a $20 billion investment fund while bringing in $500 million yearly in profits.
Avoid Looking Too Fancy
Thanks to analyzing difficult investments, I’ve been doing most of my earnings for years. Despite this, investors should stick with straightforward investments such as mutual funds, individual equities, government, corporate bonds, etc.
People not trained in financial analysis will have a tough time analyzing sophisticated investments such as real estate partnership units, derivatives, and cash-value life insurance. This is because it is a very tough task to perform. You must be aware of how to accurately develop cash-flow predictions.
Using the information provided by cash-flow predictions, you will need to be able to calculate essential metrics such as internal rates of return and net present values. The complexity of financial analysis is in no way comparable to that of rocket science. Nevertheless, to be successful at it, you will need a bachelor’s degree in accounting or finance, a computer, and a spreadsheet application (like Microsoft Excel or Lotus 1-2-3).
In conclusion, avoid these five dumb mistakes when investing: not diversifying, being too conservative, trading too much, falling for “get rich quick” schemes, and listening to the wrong advice. With some knowledge and patience, you can make wise investment choices that will pay off in the long run.
Disclaimer: Investing in stocks, cryptocurrency, or other assets is risky. Reviewed4me.com doesn’t offer financial or tax advice. Any decision to invest in the financial markets, regardless of the product, is a personal one that should be taken after careful research, including a personal risk and financial assessment and professional advice if needed. We’re not liable for any financial or other losses.