7 Mistakes Investors Make to Nope Out Of
- June 27, 2023
- by Angela
Many people think that only experts know how to make money investing. How do you think investment experts became experts? They had to start somewhere and over time they learned from their mistakes. So that you don't make the same mistakes as them, this article will serve as a guide to what mistakes you should avoid making with your investments.
1) Mistake No. 1: Comparing yourself to others
Comparing yourself to others is not good, not only when you start investing but also in general. They say “comparison is the thief of joy”.
You can only expect to get the same returns as some else if you both invested in the same thing at the exact same time with the same amount of money. Sure you can always look backwards and beat yourself up. Or you can listen to someone brag about the trades they did great on (which might be an exaggeration at best or a lie at worst).
Never look at what others are doing and where they invest, because everybody has their own risk tolerance, life situation and capital.
2) Mistake No. 2: Making emotional decisions
Anyone who starts investing immediately feels the strong emotions that go with it. First, after making the investment itself, and second, after it happens to go up or down. The first rule should always be that when you invest in something, don't think about what you will do with the money you will get in the end. Instead have a written plan. E.g… this money is for when I’m 65, or I will use the proceeds in 3 years to pay for kids college… etc.
Disappointment always happens when you lose money. People get emotional because they can't do what they wanted to do with the money they “should have” received.
One important strategy is to keep paper losses mentally separate from realized losses. Paper losses mean your investment dropped, but you haven’t sold it yet. Realized losses mean you sold out of it and converted what was left back to cash.
One sure way to fail at investing is to pull your money out of the market during a crash. That locks in the loss and makes it real. The best thing to do during a crash is to refer to your written plan (for example “hold until retirement”) and stick to it. Emotional decisions when investing typically lead to losses for ordinary investors. The 2007 market crash was a great time to either sleep through it or perversely put more money in. Pulling money out would have been the worst move possible in 2008 but many individual investors did just that.
3) Mistake No. 3: Trying to time the market
Ideally you would invest when the prices are the lowest and sell when the values are the highest. The old “buy low, sell high” strategy. Well good luck with that because honestly, nobody ever knows when the bottom or top will be.
Trying to time the market is a little like gambling in a casino on slot machines. You need to match three signs to win the jackpot. You need to know when to get in, what to buy, and when to sell out. If you miss just one of these items you didn’t “win”, but that is okay because nobody can do that.
One strategy is to dollar cost average each month and follow the “buy and hold” strategy. Given that, proceed to ignore what happens in the market day to day.
Timing the market isn’t just about trying to sell high, it can also be related to mistake #2 above and selling low to try and prevent even more losses (yet inadvertently locking in those losses).
4) Mistake No. 4: Ignoring your other obligations
If you want to invest without thinking about how you will pay your other monthly bills, know that you should always set aside money for paying monthly obligations as well as for investing. The monthly obligations of course come first.
If you happen to be short on cash when an emergency comes up you might be forced to sell stocks and bonds. This could be a break even situation which would be okay. It could be at a loss (locking in that loss). Or hopefully at a nice profit, but that would trigger the need to sell even more to cover the short term / long term capital gains tax.
That is why it is a good idea to have an emergency fund to cover unexpected situations so that the money intended for investment does not suffer and thus cause you more harm than good. It is possible to take a loan out of some 401(k) plans, or even do an early withdrawal without penalty. However in these cases you either end up paying interest, or “lose space” in terms of total contributions growing tax free.
5) Mistake No. 5: Taking a distribution or leaving money with previous employer instead of doing a rollover
Many people who change jobs either withdraw their retirement funds (so they can spend it), or fail to roll it over. When they withdraw it (aka taking a distribution) that money is taxed as income and includes a 10% penalty.
Oftentimes employer sponsored retirement plans offer a poor selection of funds with high expense ratios (basically gouging you). For more on what an expense ratio is see our two part post - What is an Expense Ratio Part 1 and Part 2.
When you change jobs you are allowed to roll your 401(k) funds to your own IRA account. This is completely free and means you can then access all kinds of investment options including funds with super lower expenses (which is great long term for you). While it seems intimidating, all it takes is a few forms to complete the process.
6) Mistake No. 6: Missing employer matches
If your employer offers a 401(k) plan they also likely offer some sort of contribution match. This is free money for you if you choose to take it. In order to get it you need to contribute up to the employer match amount.
For example, let’s say the employer match is 3% of your salary. If you contribute 3% to your 401(k) they will effectively double that contribution. This is good for a couple other reasons. 1) the contribution you make lowers your taxable income. 2) the matching contribution your employer makes is tax free. 3) the total amount (6% in this case) grows tax free in the account.
Contact your HR department so you can get clarification on how their matching contributions work. If you don't do this, you are leaving free money on the table!
7) Mistake No. 7: Not contributing to your retirement account
Many don't invest money in their retirement account for fear of losing money. That is a valid concern, however over a long period of time (15+ years) stock and bond funds tend to do pretty well. Cash on the other hand gets absolutely destroyed over similar periods due to inflation (you know how prices are always rising)...
By not contributing to your retirement account you are losing out on tax free gains and the power of compounding. The best thing you can do is contribute what you can automatically to your 401(k) plan or self directed IRA. Then you don’t have to think about it except at each annual checkup.
Back to the “fear of losing money” excuse… There are a wide range of investment options tailored to different risk tolerances. Generally the younger you are the more aggressive you can be. The idea of “aggressive” or “safe” investing depends on your overall asset allocation. A simplified version of this is stocks are aggressive and bonds are safe. In reality it is more complicated than that and a financial advisor can help explain it. For an introduction see our post on asset allocation and what you can invest in. Consider that an asset allocation of 30% in stocks and 70% in bonds (which is considered very conservative) offers a big advantage in total returns vs cash and avoids the large gut wrenching draw downs that come with a stock heavy asset allocation.
In summary, investing carries risk but so does not investing!
Conclusion: Everybody makes mistakes, and there are some very common ones ordinary investors tend to make which we documented above. For more information see our post on sleeping good at night while investing. Also see our post on 8 costly 401(k) mistakes.