There is no single secret to investing. Anyone who has dabbled in the stock market knows that it is a complicated beast to tame, and that it comes with both highs and lows. The market so complex that despite thousands of books being written on the topic, many people — amateurs and brokers alike — still find themselves perplexed at the latest stock charts or the most recent earnings reports.
While there are many tips that can improve a portfolio, the way most investors miss out on value is not because they are ignoring the latest Wall Street advice but rather because there are fundamental flaws in the ways that they approach investing. It is surprising at how well a balanced, healthy, thought-out portfolio can return over even a short- or medium-term time span.
With that in mind, let’s look at seven of the most common pitfalls of investing.
1. Paying too many fees
A lot of investors get slammed by brokerage fees that are above what they should be paying for their investment needs. While it is easy to attribute this to greedy brokers or hidden costs, a large part of this simply stems from a lack of awareness. There’s no harm in shopping around within or even between brokerages to see what types of investment plans or setups are best suited to your needs. Also, trade in a way to maximize the value that you get out of your plan — if you have to pay a fee to make a transaction, it doesn’t make much sense to buy shares three times when a larger, one-time purchase will suffice.
2. Don’t try to mimic Wall Street
Wall Street is lauded as the Mecca of investing, and, in a way, rightfully so: Many of the most profitable indexes and brokerages are located in the heart of New York City. However, that doesn’t mean that what they’re doing is right for every investor. Many people on Wall Street are willing to take on substantial amounts of risk for marginal gains in reward, which may be correct for a hedge fund but hardly suits the needs of an average investor. In addition, many Wall Street firms engage in day trading or other high-volume transactions. While this can lead to huge profits if executed in a timely and correct fashion, again, it is not what is best for the average stock market enthusiast. Analysts often disagree with each other on recommendations, as well, meaning that everything you hear from the Street should be weighed carefully before any actions are taken.
3. Not diversifying
Diversification is one of the oldest tips in the book, yet it is surprising how many people do not follow this piece of advice. Not diversifying leads to bad things when companies or sectors collapse. Think back to the dot-com bubble of the early 2000s, when many who had tech-heavy portfolios saw their savings virtually wiped out when the sector tanked. This can be solved by simply ensuring that portfolios have shares of not only different companies but companies that are in different sectors and that are unlikely to be impacted similarly by any one given political or economic event.
4. Not rebalancing
Going hand in hand with diversification is the process of rebalancing a portfolio. By rebalancing means checking back on a portfolio to make sure that the ratios of value in different stocks have not become out of sync. For example, if one sector outperforms another, then the outperforming sector may constitute a significantly higher percentage of a portfolio than originally planned, and, likewise, the underperforming sector could be underrepresented. While it can be painful to trim positions in stocks that have gone up just to buy into sectors that appear to be lagging, it is a strategy that ultimately will be profitable. This is because having an unbalanced portfolio in which the lion’s share stays with the winners is one of the surest ways to lose money over time.
5. Buying into the herd mentality
Herd mentality occurs in situations where members of a group all go along with a general trend among the group’s members — think of a herd of antelope running away from lions, or lemmings jumping off a cliff. The thing about the stock market is that it is a place where following the herd mentality can be very costly. Remember that the market is all about expectations, and a stock is worth whatever someone will pay for it. If everyone thinks that a company is valuable, then the company has to not only outperform empirically but it also has to beat everyone else’s expectations if the stock is to climb higher. Again, think back to the dot-com bubble for an example of when following the herd proved very costly to many investors.
6. Don’t be emotional
It is easy to get emotionally attached to a stock, regardless of whether the stock is doing well, poorly, or holding constant. Maybe a relative worked at Ford; maybe you really love your Apple iPhone; maybe The Social Network made you hate Facebook. None of those things should affect your decision when considering a portfolio. It is important to be completely detached in order to make optimal choices concerning the stock market, given how easy it is to get carried away with emotion.
7. Not having a plan
One of the most common and deadly mistakes that casual investors make is not having a concrete plan in mind for what to do depending on how a stock performs. While it is impossible to precisely predict markets — being able to adapt to unforeseen changes is a valuable tool in investing — most of the time, stocks will generally perform in accordance with certain patterns. If a company’s earnings report falls short and causes a drop in share price, does one sell or hold? This is question that an investor should be prepared to answer before the earnings report comes out. With a bit of due diligence and careful consideration, it is not hard to formulate a response to most possible outcomes for a stock’s movements. When people deviate from a rational plan is when many of the most costly errors in investing are made.
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