Investing invariably comes with risk. But some mistakes can be avoided altogether. Here’s what to look out for.
When it comes to investing in the stock market, it’s easy to get carried away by the latest news, the hottest stocks, and stories of people striking it rich betting on that one meme stock that goes to the moon. After all, we invest to make money and grow our wealth. Why not do it as fast as we can?
In the chase for quick returns, it’s easy to forget that investing invariably comes with risk. This leads to expensive mistakes that could easily wipe your portfolio clean. Or worse, financially cripple you if you borrow money to invest.
“Rule number one: never lose money. Rule number two: never forget rule number one.”
– Warren Buffett
With that, here are five common mistakes that beginner investors tend to make — and how you can avoid them.
1. Giving in to greed and fear
The greatest challenge that comes from investing isn’t the time, effort, and brainwork that goes into analysing stocks and data; it comes from your emotions. This is easy to observe — go back to March 2020 when COVID-19 started exploding globally. The S&P 500 crashed over 30% in a matter of weeks. What were your emotions then?
The world was facing a once-in-a-century crisis. Did you panic and sell your stocks because you were fearful? Or did you calmly scoop up great stocks at cheap prices?
How you reacted to that real-life event will give you an insight to how you handle your emotions when it comes to high-stress situations in the stock market.
After the shock of COVID-19, the S&P 500 recovered in a matter of months. Many pandemic-growth stocks and ETFs emerged (Ark, Zoom, Roku, Teladoc, etc.) and went on to reach all-time highs. Maybe you remember your friends posting their quickfire gains investing in the post-pandemic stock boom. How did you react again?
Did you jump in because of FOMO? Or did you take a pause and ask whether the prices made sense? Again, how you reacted to seemingly ever-rising stock prices will give you another clue to how well you handle your emotions in the stock market.
The cycle of investor emotions.
At the end of the day, investing based on your emotions is a recipe for failure because you will always end up buying high (greed) and selling low (fear).
2. Not really understanding your investment
Many beginners buy a stock for one simple reason: they think they can make money. But when you ask them to explain the underlying business behind the ticker symbol, they are often at a loss for words. Interestingly, they watch the stock chart every day but have never read a page in the company’s annual report.
Before you invest in a stock, ask yourself:
· How does the company operate and compete?
· Does it have a long-term competitive advantage?
· Does it have a long runway for growth?
· What are the key risks that could derail the business?
· Are the CEO and management aligned with shareholder interests?
· What is the company’s financial performance over the last 5-10 years?
· Does it have a resilient balance sheet?
This list of questions is not meant to be exhaustive, but it’s a good place to start your research.
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3. Falling in love with a company
When you start doing your research on a company, you will begin to identify a few favourites that you gravitate to. You will learn what makes your favourites great companies and great investments. For me, my favourites are Alphabet, Amazon, and Microsoft (boring, I know).
At the same time, I understand that I’m not wedded to my stocks. If there comes a day where their fundamentals are no longer stable, and the risk of owning them becomes too high, it’s time to say goodbye.
Have you ever invested in stock that’s come crashing down with little to no hope of recovery? Did you cut your losses (as painful as it may be), or are you still holding on praying for a miracle? When it comes to investing, time is of the essence. Holding on to a bad stock for five years means you would have missed out on five years of potential gains from a good stock you could have bought instead. Those are five years you can never get back.
So how do you know when it’s time to actually cut your losses? That’s where doing your research and due diligence comes in. When you really understand your investment, you will be able to identify when a company is facing a temporary setback or a long-term structural decline.
4. Timing the market
Everyone loves timing the market, but no one is able to time it perfectly every single time. Why is this so? Because no one can predict the events that happen in the real world. No one foresaw that COVID-19 would explode in March 2020. No one expected China to severely regulate its tech companies. Not many thought that Russia would actually invade Ukraine. All these real-life events have very real effects on stock markets and economies.
Like a mentor of mine once joked, “If I can’t predict my wife’s mood in the morning, how can I predict what will happen in the markets tomorrow?”
You can ‘time’ the market by trading during windows of opportunity — buy when stocks are cheap, sell when they become overvalued. But even when you do that, you will still have no idea how the world will be like tomorrow, and which way the stock market will go.
5. Going all in
In this day of YOLO bets and stocks going ‘to the moon’, many beginners may just decide to go all in on one single stock. The problem is that we only hear of people who struck it rich, but hardly ever of those who lost everything doing the same thing.
Let’s say you invested your entire portfolio of $100,000 in Netflix at its peak of $690 in Oct 2021. Six months later, the stock is now worth $348 a share — a 50% plunge. And your six-figure portfolio is now only worth half what it once was.
Risk on a single-stock portfolio.
However, if you had split your portfolio equally across 10 stocks, your stake in Netflix would only cause a 5% drop to your overall portfolio. At the same time, your other stocks could also do well and push your overall portfolio into the green.
Risk on a diversified portfolio.
It’s easy to be excited when stocks always move in the direction you want, but the stock market doesn’t work that way. So make sure to diversify your investments properly and you will never have to face a situation where you lose it all.
Although my title assumes that only beginners will commit these mistakes, in reality, veteran investors can also make them (we all need reminders from time to time). But as you gain more experience and learn from your mistakes, they will become fewer and far between. Remember, the goal of investing is not to get rich today, but to grow and remain rich when you decide to call it a day.
“The only mistakes you can learn from are the ones you survive.” – Jim Collins
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