One of the most important pillars of investing, made famous by the great Charles Ellis in Winning the Loser’s Game, is that the most successful investors are those who make the least mistakes.
This counterintuitive point, that investors maximize returns by prudence, as opposed to brilliance, stems from how investing gains require detailed research, emotional control and long-term patience to be reaped, all three of which are obviously not innate human traits. This is why beginners should pay the most attention to what not to do before buying stocks, bonds, real estate, cryptocurrency, or any other assets that catch their fancy.
Given the predictability of human nature, it’ll be no surprise to readers that investors are at risk of committing the same mistakes, contingent on their upbringing and individual financial situations, regardless of where they hail from. This makes it easy to offer a working list for your reference, ordered according to the investment journey from initial planning, to purchasing investments, to maintaining your portfolio in pursuit of your financial goals. Here’s what we came up with:
- Investing without a personalized financial plan.
- Investing without a thorough research process.
- Investing without diversification.
- Investing based on emotions.
- Investing based on behavioral biases.
- Investing to time the market.
- Investing while ignoring costs.
- Investing without rebalancing your portfolio.
- Investing oblivious to market conditions and the broader economy.
- Investing without conviction in your strategy.
10 common investing mistakes to avoid
1. Investing without a personalized financial plan
The gravest mistake most investors make is putting money to work without considering the role money plays in their lives, leading them to potentially invest beyond their means in assets ill-suited to help them fund their financial goals. Key questions to ask here include:
- How much money can I invest while still playing my bills and saving for emergencies and near-term expenses?
- How long do I need to invest for my given goals?
- Which investments are best aligned with my particular psychological makeup?
Readers should note that it may take decades for stocks, the world’s best-performing asset class, to offer a positive return, with a high potential of down years in the interim. A global stock portfolio earned 5 per cent above inflation per year from 1900-2018.
2. Investing without a thorough research process
When it comes to building a portfolio, the most common mistake investors make is choosing stocks or funds without knowing enough about them, opening them up to unexpected and unsatisfactory outcomes.
If you’re picking an individual stock, you should favor:
- Companies with profitable operations, ideally on a net income basis, though gross profitability scaling towards net income is also acceptable. A company must justify anything short of this trajectory with products and/or services whose differentiation in the marketplace outweighs current financial losses.
- Industries with multi-decade growth runways, enabling you to hold stocks active in those industries over the long term.
- Management teams looking to replicate past successes with the company you’re thinking of buying a stake in.
- Well-established sources of financial information, such as Stockhouse, Morningstar and Barron’s.
If you’re in the market for an investment fund, pay attention to:
- Whether it practices an active or passive investing strategy. Active funds try to pick the best stocks in the market, while passive funds simply own all the stocks in a given market, offering investors their overall return. The latter of these two approaches has better served investors over time.
- Its past performance, with a recent run-up suggesting lower returns in the future and a recent downturn suggesting higher returns ahead.
Whichever investments you end up choosing, it’s paramount that they be diversified, allowing them to work together to protect and grow your wealth regardless of market conditions.
3. Investing without diversification
A common mistake among new stock investors is putting all their eggs in one basket, building conviction in only one or a few stocks and needlessly concentrating risk that could be spread across numerous holdings.
To minimize risk, long-term investors should diversify their stock exposure by industry, size and geography, offering their portfolios the best chance at always having a stock that is outperforming, regardless of the current macroeconomic climate.
To this end, many investors choose to simply own the global stock market by allocating into a market capitalization-weighted ETF, such as those listed in step 3 of the recent article, 5 steps to mastering risk management in the stock market.
Day traders more interested in shorter holding periods can also make use of stop-loss orders, which sell a stock once it falls to a pre-determined price to control downside risk.
4. Investing based on emotions
While you may be diversified and invested in line with your financial goals, your emotions will at times urge you to make hasty changes that put your future financial wellbeing at risk. These scenarios include:
- The temptation to sell certain stocks that are dropping, despite no change in their fundamental characteristics, driven by the fear of continued losses.
- The temptation to give into the behavioral bias of herd mentality, leading you to buy certain stocks running up in price and/or frequently mentioned in financial media without adequate research to substantiate future performance.
If the manic short-term fluctuations of stocks are too much for you to bear on the road to long-term returns, consider softening these fluctuations by diversifying away from stocks into cash, bonds, real estate and cryptocurrency.
5. Investing based on behavioral biases
Our next common investing mistake, tangentially related to #4, is participating in the stock market while committing behavioral biases, a term for failures in reasoning human beings are distinctly susceptible to. Here are three of the most well-known among investors:
- Action bias, or the feeling that it’s better to do something as opposed to nothing. In the case of a stock that drops precipitously, the best decision if often to hold on, supposing there are no notable changes to the underlying business. In the case of a stock on the rise, the desire to take profits often proves hasty compared to gains to be reaped years down the line.
- Authority bias, or the feeling than an expert deserves our conviction, when they might in fact be wrong about their financial advice upon further investigation.
- Confirmation bias, or the tendency to favour information that supports our views about an investment, nudging us away from dissenting views that would make our due diligence more well-rounded.
6. Investing to time the market
Among the extensive list of behavioral biases, each a testament to the limitations of the human brain, the one that deserves a mention all on its own with regards to investing is overconfidence.
Given the direct correlation between money and quality of life, the stock market is full of companies and commentators touting their potential to generate supersized returns. This makes novice investors especially vulnerable to falling for compelling predictions about the future, including:
- Believing they’ve stumbled upon the next Amazon, Microsoft or Alphabet, leading them to ditch diversification for the promise of riches.
- Believing they know how a stock will react based on an earnings report, or how the broader market will react to new economic data on inflation, employment or related policies, leading them to place an outsized bet on a by definition unknowable future.
Readers should either ignore any kind of advice that promises clairvoyance or substantiate it through research before acting on it with their wallets.
7. Investing while ignoring costs
One of the foundational investing mistakes to avoid to maximize how much money ends up in your pocket is paying higher fees than you need to.
Investors can minimize fees by sourcing the lowest-cost trading providers available in their country of residence. Canadian investors can trade stocks and ETFs with no commissions through Wealthsimple, while low-cost providers like Questrade and Interactive Brokers charge only a few pennies per trade compared to C$10 at most of Canada’s Big Six banks.
When it comes to stock funds in particular, investors should also make sure their annual fees are commensurate with the value they provide. For example, if an active fund strives to outperform the TSX but does not achieve this after fees, the fund managers are arguably overcompensated. Conversely, if you’re interested in a broad market index fund tracking the TSX or S&P 500, managing such a fund does not require any special insight – merely buying or selling to match the index to the portfolio holdings – meaning you should invest where the fees are the lowest.
8. Investing without rebalancing your portfolio
Even if you’ve done everything right and tailored a portfolio aligned with your life plan, you may still fail to realize that plan to its fullest potential by not rebalancing your investments.
Rebalancing means nothing more than realigning your portfolio with steps #1 and #3, such that everything inside of it is optimized to serve your financial health over the long term. A good rule of thumb is to invest any new money in such a way as to nudge your portfolio towards its intended asset allocation, or the particular mix of investments best suited to your goals.
9. Investing oblivious to market conditions and the broader economy
While diligently saving and investing will allow compound interest to work its magic and build your nest egg, you can stay ahead of the average investor and expedite this process by buying assets when they’re undervalued. This requires keeping an ear to the ground for certain companies and sectors that find themselves out of favour, even though they remain fundamentally sound and worth your capital. As 2024 draws to a close, two examples of undervalued sectors include junior miners and international stocks.
Junior mining stocks are unloved at the moment, despite commodities like gold, silver, copper and uranium flirting with or making new all-time-highs, because most of the underlying companies are pre-revenue and heavily reliant on capital raising, making their stocks roller coaster rides unfit for the average investor. Nevertheless, high-quality assets being developed by seasoned management teams represent potentially exponential return drivers for those immune to the volatility.
International stocks, which we’ll specify as non-US, have taken a backseat in most portfolios or given it up entirely because of the secular outperformance of U.S. stocks following the Great Financial Crisis of 2008. If we look further back into history, however, it becomes clear that international stocks have had their moments in the sun, including as recently as 2000-2010, and are positioned to have another given high valuations in the U.S. market.
10. Investing without conviction in your strategy
Our final common investing mistake to avoid encompasses the previous nine, and it involves giving in to the idea that you can get by in life without investing.
Deceptively easy to fall into, many make this mistake by latching on to common falsehoods about the stock market, such as it being rigged against retail investors, or the need to be wealthy to participate. Others may simply refuse to commit to the reading required to understand how the stock market works and how it effectively equips you with a second income that continues to grow while you go about your life.
Conviction may take some initial effort to build, but once you do, informed by the fundamentals we’ve covered in this article, you will likely never look back, holding steadfast to your role in the cycle of innovation from novel product or service, to attracting investments to grow market share, to hopefully considerable gains returned to you with a higher share price.
If you’ve yet to put money to work in the stock market, or find that you’ve committed some of these investing mistakes, you aren’t alone and it isn’t too late to pivot. Your future self will thank you.
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