As someone who has defended stock brokers from charges of wrongdoing, I believe I know a fair amount about investor behavior. If you’ve finally decided to start investing your savings into the stock market, you may want to consider that a lot of the mistakes investors generally make in the market can be almost entirely avoided.
If you’ve decided to take the DIY approach to investing in stocks then your biggest asset may not be tons of professional help or mathematically complex valuation models, but rather your attitude towards the process. A high IQ or analytic ability can only go so far if you can’t control your emotions while putting your money in play.
So, if you’ve dedicated yourself to succeeding in the market then here’s a list of some of the most common mistakes new investors make so that you can learn to avoid them.
- Panicking When The Market Drops
All good things come to an end and this is true for both your life and the economy. If markets only went up everyone would be rich, there would be no bear sightings and you probably wouldn’t be reading this article right now. But markets don’t go up in a straight line; they frequently are volatile and sometimes collapse.
The volatility of the markets is what scares investors the most. People obsess about the ups and downs. People often panic when they see their investments drop like a stone in a pond. But if you’ve done your research and are confident in your picks, there’s less reason to worry. In fact, a lot of professionals would consider a sudden, dramatic drop in stock prices as a great opportunity to buy more.
- Getting Carried Away With Market Euphoria
Conversely, it’s easy to get carried away when things are looking up. After a spree of advances on the stock exchange you may have experienced a drastic increase in personal wealth. It’s okay to celebrate this momentarily, but it’s equally important to keep things in perspective. Reanalyze your stocks when the market is hitting all-time highs and see if anything seems to be over-valued.
Contrary to popular belief, selling is your best option when you think the market is getting ahead of itself. To quote the living investment legend Warren Buffett, “Be greedy when others are fearful and fearful when others are greedy.”
- Not Paying Attention to Trading Fees
Trading fees may seem like a minor inconvenience the way most brokerage houses in the country make them appear, but you must pay careful attention to how much you spend on either buying or selling. Even small percentages of total transactions can eat into your overall return in the long term. What seems like a minor amount at the moment is worth a lot more in the future and over the long term.
- Putting All Your Eggs in One Basket
One of the most common mistake investors tend to make is to not diversify their portfolios enough. There’s a great example of how a Columbia senior had managed to make $120,000 through his investments and then lost it all on one single company, Puritan-Bennett Inc. This particular investor learned his lesson in terms of over concentrating positions and went on to become of the most successful hedge fund managers of our time – Daniel Loeb. So try to avoid the same mistake he made and you’ll save yourself a lot of pain in the long run.
- Failing to Regularly Rebalance
If you’ve allocated your wealth in a certain configuration try to take the time once a year at least to reassess your portfolio. So, for example, if one particular investment is doing much better than the others and now forms a much larger part of your overall net worth than you expected, consider cutting down on it since you may be over exposed to that asset class. Market studies have shown that asset allocation is crucial to returns achieved in investing.
Probably the single biggest folly of inexperienced investors is to fall into the trap of over trading. Trading too often has two very considerable disadvantages. First, your costs go up as you pay more in commissions to your broker – not good when you need all the money you can get to better compound for the future.
Second, you can trade in a stock every second of the day, but the fundamentals of the business you’ve invested in will certainly not change that quickly. What you are effectively doing is speculating on what the market is going to do, and a lot of experienced investors will tell you this is the quickest way to the poorhouse. Likewise, you are trying to beat professional investors at a game where they have the advantages, like not having another job to do during market hours.
The final most dangerous mistake investors can make is to borrow against their shares or securities in their account. Stock prices, by their very nature, are volatile but when you borrow you’ve adopted a fixed cost which you will have to bear regardless of what happens. If the market takes a turn for the worse your losses will be amplified due to the leverage you’ve adopted. Many have gone bankrupt doing exactly this. At the most inopportune time, your broker-lender can require additional capital or sell your investments.
Even the most experienced investors make mistakes and experience losses – it’s just the nature of the beast. But you can minimize your risks considerably by avoiding these common slipups that newbies tend to make when they’re starting out.
About the Author: Andrew May is a FINRA arbitration attorney and the founder of May Law, a financial and commercial firm in Chicago. He’s passionately committed to educating everyone from brokerage firms to individuals on the legal and practical matters of investing. Andrew is also a frequent contributor to several online business and finance publications. To learn more, visit www.Maylawpc.net.