During these turbulent economic times, it has been difficult for many people to invest. However, investing is an absolutely imperative exercise in order to achieve your various financial goals. Here are five common pitfalls investors face and solutions to help you avoid them.
1) Getting a late start. Few investors start investing when they can, but wait until they must. The earlier you start, the easier it will be to achieve your goals. Let’s compare an investor who starts investing $2,000 a year, at age 16 when they first start working versus the person who starts investing at age 26, when they have steady employment.
Assuming this practice is continued until age 65, with an ARR (annual return rate) of 10 percent, the early investor will have accumulated $2,114,379. The procrastinator will be left with a relatively paltry sum of $802,895. The difference is astonishing. Even if all you can afford to do is invest $25 a month, you should still put it to work for you, sooner rather than later. The extra time can provide spectacular results.
2) Not doing your due diligence. Many people will put more time into purchasing a stereo than they will into selecting a suitable investment. It should be the other way around. Do the proper research, and make sure you understand what it is you are buying.
Another point is to be objective. Emotions have no place in investing. A stock price will increase because of the fundamentals as portrayed in the financial statements, not because you have a gut feeling that it will take off.
Performing your due diligence is also relevant when it comes to selecting a financial advisor. If someone else is going to select your investments, you better make sure they are competent and experienced enough to do so.
3) Confusing investing with speculating. Many people believe they are investing when in fact it is more like gambling. It is OK to speculate with a portion of your funds, but you must realize that is what you are doing. The first speculative concept to avoid is day trading (i.e., trading very rapidly in and out of a stock). If it were as easy as it seems, then professionals with more time and better resources would be doing it. Since very few do, it is a sign that you should not pursue this path.
A similar concept is investing over a short period of time in risky stocks. Investing in equities with an expectation of making a big gain over the next six months or year is more along the lines of speculation than investing. To truly be investing, you need quality investments over a substantial period of years.
Perhaps the most devastating mistake an investor can make is listening to a “hot tip.” If it sounds phenomenal, then get all the information, and do your research. If you still like it, then proceed. Rarely will the “investment” be deserving of your capital. Simply because a friend’s uncle says that a stock will soar does not make it so. Once again, do the proper research.
4) Not diversifying adequately. Investors have a tendency to overweight their portfolio with a specific company, industry or investment type. A balanced portfolio should consist of all three of these. Too many people put all of their eggs in one basket, and get burned badly with a market reversal. There are professionals who have used focused portfolios successfully, but they are rare, and should not be imitated.
This does not mean you should be invested evenly between bonds and stocks, but it is a commendable to have a variety of both. With that being said, it may be advantageous for most young investors to contemplate owning predominantly equities. This can be helpful in overcoming the obstacle of keeping up with inflation. However, proper portfolio diversification needs to be made on an individual basis, after considering your risk tolerance.
5) Buying high and selling low. All too often, people take a position in a stock after the price has gone up, and sell out when the inverse occurs. It should be the other way around. Lack of conviction can make it tough to invest during challenging times. However, if the proper research has been done, this should not be a problem.
Ironically, recessions and market crashes provide excellent opportunities for investors. Often times, these apocalyptic and euphoric manias are driven by the media and analysts’ reports, which simply follow the herd.
A contrarian (i.e., an investor who behaves in opposition to the prevailing wisdom) mindset, with the proper research, can often prove ideal to finding the best values during chaotic market movements. This is especially true for young investors who have time on their side to allow for a market turnaround.
Josh Bateman is a senior at Penn State University and founder of JDB Financial Services, LLC.
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