Common mistakes when investing

Making mistakes when investing is just part of being human  — this is also known as behavioral economics —  We aren’t always rational, and the decisions we make can therefore flawed.

Why do we buy too late — and then sell too soon?

Why do companies with stock symbols that come earlier in the alphabet have a small but measurable advantage over those that come later?

Why do we refuse to withdraw money from a savings account, even when we are drowning in debt?

Mistakes are common when investing, but some can be easily avoided if you can recognize them, but the worst mistake is failing to set up a long-term plan, allowing emotion and fear to influence our decisions, and not diversifying a portfolio.

Other mistakes include falling in love with a stock for the wrong reasons and trying to time the market or not understanding the investment we are making.

One of the world’s most successful investors, Warren Buffett, cautions against investing in companies whose business models you don’t understand. The best way to avoid this is to build a diversified portfolio and invest in indexes. If you do invest in individual stocks or alternative strategies, make sure you thoroughly understand what you are investing in before you invest.

Additional Mistakes to avoid:

1. Falling in Love with a Strategy or an Equity. Too often, when we see a company or a strategy we’ve invested in do well, it’s easy to fall in love with it and forget that we bought this as an investment. Always remember, you bought this strategy to make money. If any of the fundamentals that prompted you to buy into the strategy change, consider selling it and changing to a new strategy that is aligned with market reality.
2. Lack of Patience: I suggest a slow and steady approach to portfolio growth with the expectations that this will yield greater returns in the long run. Expecting a portfolio to do something other than what it is designed to do is a recipe for disaster. This means you need to keep your expectations realistic about the timeline for portfolio growth and returns.
3. Buying and selling as a strategy: Jumping in and out of positions, is another return killer, transaction costs can eat you alive—not to mention the short-term tax rates and the opportunity cost of missing out on the long-term gains of sensible investments.
4. Attempting to Time the Market: Attempting to time the market also kills returns. Timing the market is extremely difficult. Research shows that most of our portfolio growth is made by choosing strategies aligned with our life goals and not trying to time markets.
5. Waiting to Get Even: Getting even is just another way to ensure you lose any profit you might have accumulated. It means that you are waiting to sell an equity or strategy loser until it gets back to its original cost basis. In behavioral finance we call this a “cognitive error.” By failing to realize a loss, investors are actually losing in two ways. First, they avoid selling a bad investment, which may continue to loose until it’s worthless. Second, there’s the opportunity cost of the better use of those investment dollars.
6. Failing to diversify: Nobel Prize winner Prof Harry Markovitz said “Diversifying sufficiently among uncorrelated risks can reduce portfolio risk toward zero.” So it is wise to stick to the principle of diversification. As a rule of thumb, do not allocate more than 5% to 10% to any one investment.
7. Letting Your Emotions Rule: Perhaps the number one killer of investment return is emotion. The concept that fear and greed rule the market is true. Investors should not let fear or greed control their decisions. Instead, they should focus on the bigger picture. An investor ruled by emotion may see a negative return and then panic and sell, when in fact they probably would have been better off holding the investment for the long term. In fact, patient investors may benefit from the irrational decisions of other investors.

How to Avoid Mistakes

Below are strategies advised to avoid these mistakes:

1. Develop a Financial Plan: Determine what your life goals are, and how much how to invest in order to get there. If you don’t feel qualified to do this, seek a professional certified financial planner. Remember why you are investing your money, and you will be inspired to achieve life goals as opposed to making a profit and you may find it easier to determine the right allocation for your portfolio. Do not expect your portfolio to make you rich overnight. A consistent, long-term investment strategy over time is what will get you where you want to be and life the life you dream off.
2. Monitor the Plan: As your income grows, you may want to align your goals with the improved lifestyle you have achieved. Monitor your investments. At the end of every year, review your investments and their performance. Determine whether your strategy should stay the same or change based on where you are in life.
3. Allocate Money to pamper yourself: We all get tempted by the need to pamper ourselves. It’s the nature of the human condition. So, instead of fighting it, go with it. Set aside “pampering money.” You should limit this amount to no more than 5% of your liquid assets, and it should be money that you can afford to spend.
4. Do not use retirement money. The day will come that you can no longer create income and you will need your retirement accumulation to provide you with the alternative to working income. This is essential to understand. Contribute to retirement religiously, invest it in long term safe strategies and never touch it no matter what the seemed opportunity.

Mistakes are just part of the investing process. Knowing what they are, when you’re committing them, and how to avoid them will help you succeed in life. To avoid committing the mistakes above, develop a plan, and stick with it. If you must do something risky, set aside money that you are fully prepared to lose and will not have impact on your lifestyle.