Each person's individual investing strategy may be different, but there are things every investor should avoid. Many individuals start investing with little to no education about the markets and learn the hard way by losing money. Instead, take note of these four investing mistakes to avoid.
1. Trying to Time The Market
Popularized by films and social media, day trading appeals to many because of the high rate of returns. Not only that, it’s been personified as a get-rich-quick method when in reality that is far from the truth. Day trading or trying to time the market is highly risky and typically results in loss of principal and even more.
Instead of trying to time the market, you should aim to slowly add to your portfolio and dollar cost average over time to let your money grow. Certainly, there are successful active managers, but risking your retirement to try to make extra money is not worth it. Instead, look for mutual funds and exchange-traded funds (ETFs) that suit your investing goals, and use them to create an investing strategy that fits your needs and allows the overall market to build your wealth over time.
2. Failing to Properly Assess Risk
It is easy to get caught up in the glamour and returns of investing and forget that just as quickly as the market built your wealth, the market can take it away. Many investors fail to see the downside risk and only focus on upside potential. If you invest over the long term, there will inevitably be a period of time when you lose money. It is how you mitigate the risks and insulate your portfolio that matters.
Another purpose of risk management is to implement a buffer between your investments and your emotions. The human mind can be your own worst enemy because investing is a long-term game and the human mind is geared for instant gratification. Irrational thoughts tend to enter the mind in times of elevated levels of stress. (For related reading, see: How to Avoid Emotional Investing.)
Risk management will allow you to detach emotionally and stick to your game plan through the ups and downs of the market.
3. Not Diversifying Your Investment Portfolio
Putting all of your eggs in one basket is not a good investing strategy. You can make a lot of money if the technology and entertainment sectors do well and that's where your money is, but putting all investments into one area will likely not perform well long-term.
Instead, you should look to diversify your holdings across a few different assets that have different correlations. The goal with diversification is if the market should take a hit in a certain sector or a certain market cap, your portfolio will not suffer as a whole.
4. Not Understanding Your Investments
Lastly, it is critical that you understand what you are buying. Understanding how a company and its stock works has two major benefits. First, you’ll know what to expect out of the stock or fund. If you enjoy technology and know a lot about it, you'll know if what a company is saying is good or bad. Many times, the market reacts as a pack, but if you truly understand a company, you may realize some market moves are irrational.
Second, you can talk about your portfolio with confidence. Individuals sometimes buy investments because a family member said it was a good idea. Ultimately it is your decision and your money that is on the line. Having the ability to talk about your investments not only will make you more aware, but also show you have confidence in your plan of attack.
The stock market can be an intimidating place to the untrained eye, but it can provide you with wealth-building potential. Avoid trying to time the market. Instead, ride the waves and let your money grow slow and steady. Do not take on unnecessary risk unless you absolutely must. Diversify, diversify and diversify some more, ensuring your investments are not all in one basket. Lastly, understand what you are investing in. These actions will put you on the right path to building your wealth.
(For more from this author, see: 3 Ways to Prepare for Life After Retirement.)