When learning any skill, it is best to start young. Investing is no different. Missteps are common when learning something new, but when dealing with money, they can have serious consequences. Here we look at some of the common mistakes young investors make, and how to avoid them.
Procrastination is never good, but it can be especially detrimental while investing, both because the markets move so quickly (in terms of short term investing) and you can miss out on higher return because less would reinvested in the long run. Good investment ideas are not always easy to find. If, after doing research, a good investment idea arises, it is important to act on it before the rest of the market takes note and beats you to it. Young investors can be particularly prone to not acting on a good idea out of fear or inexperience.
2. Speculating Instead of Investing
An investor's age affects how much risk an he or she can take on. So, a young investor can seek out bigger returns by taking bigger risks. This is because if a young investor loses money, there is time to recover the losses through income generation. This may seem like an argument for a young investor to speculate, but it is not.
Instead of speculating and gambling, a young investor should look to invest in companies that have higher risk but greater upside potential over the long term.
3. Using Too Much Leverage
Leverage has its benefits and its pitfalls. If there is ever a time when investors have the ability to add leverage to their portfolios, it is when they are young. As mentioned earlier, young investors are more able to recover from losses through future income generation. However, similar to speculation, leverage can shatter even a good portfolio.
Even if a young investor is able to stomach a 20-25% drop in his or her portfolio without getting discouraged, the 40-50% drop that would result at two times leverage may be too much to handle. Keep in mind that leverage adds a level of sophistication, so be sure to do your due diligence and learn about how it works before you jump in.
4. Not Asking Enough Questions
If a stock drops a lot, a young investor might expect it to bounce right back, but more often than not, it is down for good reason. One of the most important factors in forming investment decisions is asking questions. If an asset is trading at half of an investor's perceived value, there is a reason and it is the investor's responsibility to find it. Young investors who have not experienced the pitfalls of investing can be particularly susceptible to making decisions without locating all the pertinent information. Read analysts reports and follow the news – knowledge is power.
5. Not Investing
As mentioned earlier, investors have the best ability to seek a higher return and take on higher risk when they have a long-term time horizon. Investors have their longest time horizons, and therefore a high tolerance for risk, when they are young. Young people also tend to be less experienced with having money. As a result, they are often tempted to focus on how money can benefit them in the present, without focusing on any long-term goals (such as retirement). Spending money now instead of saving and investing can create bad habits and contribute to a lack of savings and retirement funds. (See more: Young Investors: What Are You Waiting For?)
The Bottom Line
Young investors should take advantage of their age and their increased ability to take on risk. Applying investing fundamentals early can help lead to a bigger portfolio later in life. There are also many risks that a young/less-experienced investor will face when making decisions. Hopefully, avoiding some of the common mistakes above will help you embark on a fruitful investing career.
To learn more, see Investing 101: Tutorial.
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