Those new to investing can be excused for not knowing what they don’t know, ya know? When we are new to a topic or practice, we tend to rely on natural intuition to carry us along and feel comfortable this will provide us with enough success until we truly grasp the intricacies. Unfortunately, this is may not a great approach to investing considering it is your wealth that is at stake. I get the opportunity to speak with a lot of people about their investments, spending, and their general approach to money. Here are common mistakes I see investors make when they dip their toe into the murky investing pool.
Don’t put the cart before the horse. Before you invest, you need to be sure you have money to invest. That means spending less than what you make and not having high interest debt. If you are paying more in interest on debt than you can reasonably expect to make in investing, it is typically better to be paying on debt rather than investing.
It is common thinking that if you could just make some more money than all of your problems would be solved. Spending is typically a behavior problem, not income. It is likely that the more you make then the more you will spend. Take a good hard look at your spending and pay off your debt.
One of the hardest parts about being a human is to set your emotions aside and not let them impact a decision. Even the most seasoned investors can fall victim to this from time to time. In March of 2020, you couldn’t turn around without hearing something about Covid being the end of times. Investors responded and in the 34 days between February 14 and March 20, the S&P 500 lost 31.81%(!) of its value. I can remember following the market and watching as stocks crashed so fast the stock exchanges would halt trading to attempt to avoid a total collapse.
Many people, advisors included, sold off large amounts of money to avoid losing any more value. I am sure you know the rest of the story. By August, the market had already recovered and then continued to climb to all-time highs. Anyone who sold off their holdings not only locked in their losses but missed out on the gains later on in the year.
This same narrative played out during the dot com collapse of 2001 and the banking crisis of 2008, though the recoveries for those took more time. It seems about once a decade the market tries to teach us this lesson but as the trolls in Frozen sing, "people make bad choices when they're mad or scared or stressed." (Shoutout to all my parents of toddlers out there) These types of events can be the best or worst times for investors depending on their behavior. Keep a level head the next time we go through one.
When I graduated in college and achieved my lifelong dream of sitting at a desk and overseeing transportation of food shipments (that beeping noise is the sarcasm detector going off), I began investing by strategically looking at the name of funds and investing into what I thought sounded good. Sound familiar? I think this is typical and everyone assumes it is good enough. It isn’t.
Here is why. Let’s pretend you are investing $5,000 per year for 30 years. The difference between a 7% return and a 8% return in that time equals out to $94,112. That is only for a 1% difference in return. What if you went from 5% average return to 9%? $349,343! The more money you are investing, the bigger the difference is going to be.
While working with an advisor has been shown to add around 3% to your average returns, I get some people want to go it alone. Do your research. Talk with people who have shown the ability to successfully invest over a long term period of time. Beware of folks who hit it big on an individual stock one time or talk about the latest hot tip they have. These are not sustainable and based a lot on luck (more on this later). Utilize this website and other knowledgable sources. Good investing is not intuitive for most people. There is a reason Warren Buffet spends 80% of his time reading and researching. Even the best know they don’t know it all. It can help to have someone in your corner who knows a lot.
Understand your goals and time horizon.
Know you risk tolerance AND risk capacity (people neglect the second one).
Maintain an appropriate asset allocation.
Choose the correct type of accounts for your assets.
The list could go on and on but I will leave it there. There are core fundamental concepts that can make up a solid foundation. You can still make mistakes from there but it doesn’t matter how pretty your house is if the foundation is junk.
"Buy low, sell high.”
"Market is due for a downturn."
Turn on any financial news station and they will give you the latest quote about where the market is now and where it is headed. Here’s the secret and I am not even going to make you pay for it.
Everyone thinks they have some secret recipe to deciphering where the market is headed and will point to how they called it right one particular time. They fail to mention the hundreds of other predictions they made that never came to fruition. Time in the market beats timing the market. Figure out what you can afford to invest and put that money in regardless of what the latest market movements are. This is called Dollar Cost Averaging and it is your best friend. Stick with your plan regardless of where the market goes.
Cryptocurrency. NFTs. Electric cars. Meme stocks.
These are just a few of the examples from the last couple of years. You can go back to one of the first known investing crazes in the 1600's where the price of tulip bulbs in Holland skyrocketed to exorborant prices and then promptly collapsed. I am not trying to say that investing in fad investments won't make you money, it could. It could also leave you with giant lossses. The trouble becomes being able to identify which fads will take off and at what point do you buy/sell in order to make money versus waiting too long and the fad has passed.
Don't believe me? Find a successful investor who has made his wealth from consistently identifying these types of investments. Good luck. Do you like the lure of trying to find the diamond in the rough? Sure, take some money to invest in your investment of choice, just don't bet the farm on it.
“I don’t make enough to put money away for retirement.”
“As soon as we pay off (enter anything that costs money here) we will start investing.”
There is always an excuse for not doing something. That is the easy way out. You want to know the true secret to success? It isn’t getting up early, cold showers, or whatever else Instagram influencers are telling you nowadays. It is foregoing short term gratification in order to set yourself up for long term rewards.
It really is that simple. Compound interest works best when given as much time as possible to work its magic. Since I seem to be on a Warren Buffet kick today, consider this; over 90% of Warren Buffet’s wealth has been generated since he turned 65. Think about that for a second. Possibly the greatest investor ever has made 90% of his money after he hit typical retirement age. You know how old he was when he bought his first stock? 11.
Take a look at any breakdown of compound interest growth. The biggest growth occurs at the end of the table. How do we get there quicker? Start earlier.
51% of investors have said they have taken an early withdrawal from their retirement accounts (Link). That is crazy to me. You are sacrificing your retirement for a short-term benefit.
Say you are 30 years old and pull out $10,000 from your retirement account. You not only have to pay typical income taxes on this, you pay an additional 10% for withdrawing early. If you are in the 22% tax bracket than that means almost 1/3 of this goes to the government, not including any state or local taxes. If you would have let that money grow until you are 65 (35 years) it would have amounted to $281,024 by the time you are 60 (assuming 10% return). You literally are adding years to the time you have to work.