Making the kind of investing mistakes that will result in losing everything is the stuff of nightmares. Films and books are full of stories that make investing seem as risky as putting everything on red at the casino. But in reality, knowing just a few golden rules can help you avoid the most common investing mistakes.
Armed with this guide regarding what not to do, we’ll help you avoid those rookie errors, so that you can start investing like a pro from day one.
The Speed Read:
1. Repay your debt and have savings
2. Don’t invest all of your money
3. Diversify your portfolio
4. Do your research
5. Base your trades on fact not emotion
#1 of investing mistakes: Not repaying debt and building emergency savings first
Investing is something that everyone should do, but not until their more basic finances are sorted.
The 50/30/20 rule recommends spending no more than 50% of your income on essentials like housing and food costs, 30% on the fun stuff like entertainment and clothes, and saving or investing the remaining 20%.
Until you are (short-term) debt-free and have an emergency savings fund, this 20% should be put towards these two financial goals, rather than investing.
While long-term debt, like a mortgage or student loan, can be paid off alongside investing, short-term debt, such as store cards, credit cards and personal loans, should be paid off first. These tend to have higher interest rates, which means not paying them off will cost you more than you’re likely to reap in any investment rewards.
If you have more than one loan to pay off, find out which one has the highest interest rate and tackle that one first. Once that’s paid off, move on to the second highest interest rate and so on.
It’s also important to have some savings built up, which you can quickly access should you need to. A recent survey found that 34% of Americans have no emergency fund, with no financial safety net should illness or job loss strike.
Experts recommend having 3-6 months of your monthly living costs. This means that if you fall ill or lose your main source of income, you’ll have time to recover without worrying about how you’re going to eat.
#2 of investing mistakes: Investing all of your money
There’s no getting around it: the value of your investments can go down as well as up, which means there’s always a chance you’ll lose money. With such volatility, it doesn’t make sense to invest everything you have.
So how much should you invest?
One of the most important rules of investing is that you shouldn’t invest money you can’t afford to lose. That includes next month’s rent payment, a carefully saved for house deposit or the money you need to go on holiday next month.
Sit down and sketch out a rough financial timeline for your future, highlighting the big spending sprees or purchases you’re likely to make, such as houses, education (or your children’s education), and eventually, retirement. This should give you a sense of how much and when you’re going to need access to your wealth.
Any financial goal that is more than five years away is worth investing for. The further away you need the money, the riskier you can afford to be with the investment, as you’ll have time to recover from any financial downturn.
#3 of investing mistakes: Not diversifying your portfolio
While it might be tempting to go all in on the latest headline grabbing stocks, like Zoom and Tesla, doing this puts your money at serious risk if something goes wrong within those companies and their stock price tumbles.
Rather than doing this, you should aim for a diverse portfolio. Portfolio diversification is simply about not putting all of your financial eggs in one basket, and you can tackle this in two ways.
The first is in the type of assets you invest in. Asset classes include stocks, bonds, funds, ETFs, gold and cash. It’s wise to spread your cash between those that will deliver high rewards but are more risky, like stocks, and those that offer smaller financial rewards but are more reliable, like bonds.
As well as benefiting from this diversity while the financial markets are behaving as expected, different asset classes behave differently during times of financial turmoil. For instance, during a recession the stock price tends to go down while the price of gold goes up.
By investing in a range of assets, the aim is for you to offset any losses in one area with gains in another. The 5/25 rule recommends that you invest in five different asset classes, and invest no more than 25% in any one of them.
You can then further diversify your portfolio by hand selecting a wide range of stocks to invest in. By choosing companies in different industries, of different sizes and in different locations, you will be protected against the serious losses that come from industry or country-specific financial events.
#4 of investing mistakes: Not doing enough research
If you’re going to select your own stocks to invest in, you need to do your homework. It’s important to know the background of the company, how they’ve performed in the past, how they’re likely to perform in the future, and how they measure up against their competitors.
The first thing to do is find out their ticker symbol, which is how they will be listed on a stock exchange. From there, a quick look online will give you a snapshot of the direction the company’s shares are heading. Below, you can see that Apple’s stock price has risen over the past year, and (at the time of writing) is trading at $113.85 per share.
But there’s plenty more to find out.
✓ Check out the company’s current performance. Is their stock price increasing or decreasing? Are you at risk of buying at the peak of their value, or do you think the price will continue to rise? Alternatively, if the price is low, is there an opportunity to buy them cheap before their value increases?
✓ Look at the company’s Investor Relation page. This holds a wealth of information regarding everything you need to know before putting your money behind that company, including financial performance, press releases and history of dividend payments.
✓ Read the 10-K (this is simply called the annual financial report in the EU). It’s a comprehensive report that covers the organisation’s history, financial statements, earnings, executive compensation and other relevant information.
✓ Consider whether the company matches your values. Is it in an industry that you want to support, and is it behaving in a way that you consider to be responsible? Read the latest articles about that company to see if there are any questions over its ethics.
If this all sounds like a lot of homework (or you’re unsure when doing enough research becomes doing too much research), it might be worth enlisting a professional to advise you. A financial advisor or full service brokerage will have the expertise necessary to offer guidance on which investments to make. Alternatively, you could invest in a mutual fund, where your money will be added to a pool of other investors’ money and assets bought on your behalf.
In both cases, it’s important to fully understand the fees involved. Essentially, the advice needs to result in an increase in reward that is higher than the amount you pay for that advice. So if your mutual fund comes with a 1.5% fee, your investment needs to grow more than 1.5% in order to justify that.
#5 of investing mistakes: Buying and selling based on emotions
It’s easy to get caught up in the headlines, giving into herd behaviour, and doing whatever you think everyone else is doing.
This tends to happen during financial crashes, where a rising sense of panic in the investment world spreads, until everyone is desperately trying to sell their stock before they become completely worthless.
Conversely, it’s easy to get swept up in the excitement of the company everyone is talking about, buying stock when the price is on the rise or perhaps even at its peak.
It’s a universal truth that markets will go up and down.
Just take a look at the graph below showing the performance of the S&P 500 over the past 20 years. As you can see, while there have been downturns — most notably in 2008, 2009 and 2013 — the general trend has been upwards. So while selling all assets during those downturns would have been tempting, it’s those that hung on to them that would enjoy the relative highs of the market today.
Doing nothing can often be the best action you can take, and while it might feel like an investing mistake, it’s actually a pro move. Markets do fall, but to date they have always risen again afterwards, so it’s just a case of holding your nerve — and your investments.
However, there are times when you will want to sell your assets, or divest from a certain industry altogether. Many people are divesting from fossil fuel companies, because they’re unlikely to ever perform as well as they did previously thanks to the focus on greener sources of energy.
Look at your investments regularly, and consider whether they’re still working for you. Are you still happy to support that company? Are the industries heading for growth, or do you think there’s going to be a global decline? Go back to the Investor Pages of the companies you hold stock in, and take a look at what they predict the next 12 months is going to look like for them.
When you’re investing in individual stocks, monitoring their performance is something you need to do regularly. Alternatively, invest in a mutual fund or ETF, and these decisions will be taken for you by the fund manager.
The world of investing is full of jargon, gatekeepers and a certain amount of maths, so it’s understandable that the vast majority of us regard it as something left to the experts. But there’s really only a few key investing mistakes to avoid, and it’s experience that gives you the confidence and knowledge you need to become an investor.
Knowing when it’s appropriate to buy and sell is something that comes over time, so if this type of investing is something you want to start doing, it’s worth experimenting with small amounts of money before you commit your savings. Many apps allow you to buy and share trades for a low fee, so these are a good way of getting started.
Alternatively, investing in a mutual fund or using a full-service brokerage puts these decisions in the hands of an expert, so you can (hopefully) just watch your investments grow.