We all make mistakes from time to time, no matter whether we’re beginners or professionals.
Some mistakes are due to psychological factors, and some are due to a lack of knowledge.
In this article, I’ve listed the most common mistakes in long-term investing that you want to look out for!
Trading Too Much
Making excessive trades is the first common investment mistake. Many investors start as long-term investors with the idea of buying low and either selling high or holding the stocks forever.
Unfortunately, different market conditions and changes in stock prices sometimes affect your investment strategy and encourage you to make more trades.
A thing that tends to go unnoticed, is that when you start to make more transactions, you also start to shift from a long-term investor to a short-term one.
The more you trade, the more you become a speculator instead of an investor.
When trading comes back-and-forth kind of action without any logical or fundamental decisions behind the trades, it becomes a problem.
Usually, the logic behind trading a lot is to buy a stock, wait for the price to go up, sell the stock, and repeat. Simple, yet infinitely harder than it seems.
It’s worth remembering that because of stock and market volatility, it’s usually a good idea to reduce timing risk by buying the same stock or mutual fund regularly. If you’re a fund investor, make sure you avoid the biggest investing mistakes in regular fund investing.
Day Trading vs. Long-Term Investing
First of all, I want to clarify that I have nothing against day traders or people who make a lot of trades. If you can achieve your financial goals by trading, it works. Simple as that.
It’s just that day trading is a lot more difficult investment strategy than it may first seem. Some individuals certainly make satisfying profits with constant trading, but you shouldn’t be fooled to think they achieve those results without a high skill level and experience.
All investing, even long-term exchange-traded funds and bond investing involves risk. Trading individual stocks carry even higher risk.
Statistically speaking, it is quite hard to make constant successful investment decisions because stock prices move pretty much randomly in short term. If you make decisions that aren’t based on the company’s fundamentals, you shift towards speculation.
Also, when you make a lot of trades, you expose yourself to high levels of transaction costs, taxes, and of course, the possibility of making bad decisions.
Beginners often make their most expensive mistakes by trading too much.
Timing the market correctly basically requires a successful prediction about the future. And as we know, making predictions is extremely hard, especially if they are about the future.
Sometimes, after a long period of success, we might succumb to overconfidence, which may lead to taking excessive risks.
Taking Too Much Risk (Or Too Little)
One of the most essential things in investing is knowing how to define your risk profile.
Taking too much risk leads to bad investment decisions. If you invest in a stock that is too volatile for your risk tolerance, you tend to sell on the decline, buy when it’s back up, and sell again when the price declines.
Long-term investment can become nearly impossible to hold on to if it is too risky. Taking too much risk clouds your judgment and makes you forget about the company’s fundamentals.
If the amount of risk is not acknowledged or the investor doesn’t fully understand her risk tolerance, the consequences can be quite devastating.
Usually, we hear stories about people who have lost everything because of a bad investment and will never invest in anything again.
That pretty much covers everything you shouldn’t be doing – which is: no diversifying, invest everything you have, ignore the risk, sell what’s left, and quit for good.
You shouldn’t risk something you need to gain something you don’t. It’s not worth it to risk your life savings for a couple of extra dollars.
Taking Too Little Risk
On the other hand, taking too little risk compared to your investment goals leads to unsatisfying results. The reason why profits aren’t high enough for low-risk investors is simply that you can’t achieve excess returns or increase your net worth with zero risk.
The idea behind defining a suitable risk level is not only to make sure you can invest in long term without excessive stress but also to ensure satisfying returns.
For example, if your risk level and the expected return rate are too low during times of high inflation, it will cut into your savings and you’re actually losing money.
Thinking long-term, your return rate should be above the inflation rate to maintain the real value of your investments.
Comparing Yourself to Others
Before you compare yourself to someone else, you should make sure that you’re playing the same game.
If you are a long-term investor, you shouldn’t compare yourself to day traders and other short-term investors.
Day traders have spectacular short-term returns because they are supposed to. Long-term investors, on the other hand, don’t aim for quick wins. You won’t gain anything by comparing apples to oranges.
A Stock Is Not the Same for Everyone
You should be careful when it comes to evaluating the investment decisions of other investors. For example, day traders and long-term investors treat stocks differently.
A long-term investor usually tries to analyze whether the stock is overpriced compared to its fundamentals. A day trader doesn’t care because it doesn’t really matter to him.
For a day trader, it might make a lot of sense to buy a stock that is at its all-time high, ride the momentum, and sell it after the stock price has gone up.
For long-term investors, it is usually a bad decision to buy overhyped and overpriced stocks. This is because the high price diminishes expected returns. More so, when stock prices fall during a bear market, it’s the riskier growth companies that usually take the hardest hits.
So, the stock itself is neither a good nor bad investment, the same stock can be a great investment for one and extremely poor for the other.
Everything’s Not How It Seems
You should also remember that people are not always honest about their investing success.
One of the quickest ways to feel miserable is to follow investors and their spectacular returns on social media and other platforms. The problem is that what you see on the web is not necessarily all there is.
People have a tendency to avoid being embarrassed, which is why we mostly keep our losses and biggest blunders to ourselves.
Also, there are numerous ways to make your portfolio performance seem better than it has actually been.
If you browse social media and compare yourself to other investors, make sure you’re playing the same game and remember to take everything with a grain of salt.
Overestimating Expected Returns
Every investor should have realistic expectations about the returns they should be getting with the risk they are taking.
Risk And Reward
When we think about compounded annual returns from well-diversified stock-based portfolios, historically we’re looking at about 10% annual returns.
For bond-based portfolios, the average rate of return has been around 5%.
So, if you’re doubling your portfolio every 7 years or so with a diversified stock portfolio, you’re doing okay. With a fully diversified index fund, you should achieve an average market return.
If you wish to achieve a higher rate of return, you will have to assume more risk.
Taking more risk usually means focusing your portfolio on fewer stocks or buying aggressive growth companies with a lot to gain and a lot to lose. Obviously, I wouldn’t encourage you to put all your eggs in one basket by buying just one company.
You should always diversify your portfolio to different companies, funds, and asset classes, as most successful investors do. The very idea of investing is to make, not lose money. By diversifying correctly, you increase your chances of making successful investing decisions.
Consequences of Unrealistic Expectations
Expecting unrealistic returns compared to your preferred risk level and portfolio leads to disappointment, unnecessary trading, and excessive risk-taking.
If your expectations are too high, you’re not satisfied with the results you’re getting. Unsatisfying returns lead to thinking that there is something wrong with your investment plan.
When you start to think you’re doing something wrong, you start doing something else. What this usually means is excessive trading and hasty decisions.
Usually, there is nothing wrong with the plan itself, it’s just the expectations that are set too high.
Sometimes investors expect exponential returns way too soon. For example, in monthly-based investing, the profits are not going to be staggering at first.
One of the most common mistakes in regular fund investing is to expect compounding returns too early.
It’s worth remembering that even the most famous investor of all time, Warren Buffet, amassed most of his fortune in his older days. About 95% of his net worth has accumulated after he turned 65.
It takes time before the profits start to make a profit. It pays to be patient, as we learned from the penny question.
Key Takeaways
So, here are the 4 most common investing mistakes to avoid:
- Avoid trading too much and focus on long-term growth.
- Taking too much risk leads to hasty decisions and diminished returns.
- Don’t compare yourself to others – concentrate on your own path.
- Overestimating expected returns leads to disappointment and difficulties in maintaining your investment plan.
The easiest way to avoid making investing mistakes is to consult a financial advisor about different investment strategies. If you feel uncomfortable investing in individual stocks, there’s always a wide selection of mutual funds covering different asset classes available.
