If you are new to investing, there is no doubt that you will make some mistakes, it just goes with the territory. However, you should familiarize yourself with these common mistakes and take steps to avoid them.
If you are new to investing, there is no doubt that you will make some mistakes, it just goes with the territory. However, you should familiarize yourself with these common mistakes and take steps to avoid them. No Investment Plan — Many investors just get started in the stock market without giving any thought as to what they are trying to accomplish. It is important to have a plan that will keep you on track and help you ride out turbulent markets. Your plan should include:
Goals — Define what you are trying to accomplish so you can measure your portfolio’s performance in meeting your goals. You will want to be as specific as possible, such as accumulating $1 million for retirement by age 60 or $100,000 for your child’s education within 15 years.
Risk Tolerance — Define how much risk you are comfortable with so you can determine an appropriate allocation for your assets. Stocks are riskier than bonds and will fluctuate more than other asset classes, so you want to figure out how much risk you are willing to assume. The younger you are, the more risk you can typically assume, since you have more time to overcome any declines in your investments.
Asset Allocation — You will want to determine how to allocate your assets across different investments, such as stocks, bonds, etc.
Diversification — Once you determine your asset allocation, you will want to diversify within each individual asset class. For example, when investing in stocks, you will want to spread your funds across large-, mid-, and small-cap stocks.
Time Horizon — Don’t wait too long to start investing, because time is your friend. If you are saving for retirement, plan on 30 years of investing to meet your goals. If you don’t allocate enough time to meet a specific goal, you will need to adjust your asset allocation to help you meet the goal within a shorter timeframe. For example, if you start saving for a child’s college education when he/she is a freshman in high school, your assets will most likely need to be allocated more heavily to stocks in an attempt to meet that timeframe. Stop the Noise — Be careful with how much time you spend and the credence you lend to the financial media. Media noise can be hard to turn off, but remember the best advice is to stick to your plan. Not Rebalancing — You will want to review your portfolio regularly and rebalance it if it strays from your target asset allocation. When you allow your portfolio to drift based on market returns, some asset classes will be overweighted at market peaks and underweighted at market lows, which may lead to poor performance. While it will sometimes feel counterintuitive to sell assets that are performing well for those that are not performing as well, your target asset allocation will lead to a stronger performance in the long term. Chasing Performance — Many investors are always trying to find the next big investment. They will rely on recent strong performance as the single factor in purchasing an investment. If a certain stock has been doing extremely well for a number of years, you should probably have invested in it years ago, since it may be nearing the end of its high performing cycle. When an investment is doing extremely well, many people will not sell and take the profit, because they are afraid that it will continue to increase in value. But there is also the risk that the investment will go down in value. You should also consider identifying a target value at which you will sell your stocks. This will help take the emotion out of your sell decisions. Becoming Too Emotional — It’s hard not to get emotional when the market encounters a severe correction, but the investors who have the ability to remain calm during these times more consistently outperform the market. If you start selling off investments at the worst possible time, you may then be out of the market when it starts to rebound. While it is easier said than done, you have to build a resistance to those things that create emotional triggers, so you don’t make bad decisions. Thoughtfully consider new information, don’t just follow the crowd, and make decisions when you are calm based on your long-term plan.