Hey reader, just a little heads up that I am not an investment advisor, and the following article is not investment advice.
Before I took my first investment course in college, I had a lot of assumptions about investing. Many of them were wrong. I thought you had to know a lot about individual stocks and companies. I believed it was much more complicated than it turned out to be. And I expected it to be so much more exciting.
Investing is kind of like film and television. The result might be sexy and shiny and cool. But if you’ve ever been on set, you know that the process of filming is usually pretty dull compared to the result. There may be some excitement, but the great majority of the time gets spent waiting around - a lot like investing!
However, lately, investing seems to have changed -- from the Gamestop chaos to the Dodge coin drama, to the general market run-up over the last two years, investing feels exciting. Ask anyone who has seen their investment balances go up over the last couple of years.
Anyone on the sidelines, if you can afford to start investing, I encourage you to get into the game because it is one of the best ways to grow your wealth. But with great return comes the need for great responsibility, restraint, and discernment. In a bull market (when the market is going up in value), everyone looks like a genius, and their investing mistakes will only reveal themselves over time. Even common investing mistakes can be costly, but one of the best ways to avoid them is to learn what these are.
When you know what mistakes to look out for, you can create a strategy to avoid them.
Now, let’s dive into some of the common beginner investing mistakes and how you can keep your investments profitable.
Not Understanding Risk
As a new investor, there are lots of different ways to think about risk. First, it's essential to understand your risk tolerance. Taking on more risk than you're comfortable with might create unnecessary stress in your life. And not taking enough risk could leave you frustrated that you're far away from reaching your investing and financial goals.
It's also important to understand risk in relation to time: the more time you have to invest, the more risk you can take because you have the time to ride the ups and downs.
Understand that the most common ways investors manage their risk are through two tools called asset allocation and diversification. When I first tried my hand at investing, back in 2007 with nothing but an eTrade account and youthful ignorance, I purchased shares of stock for various banks. That was all I invested in. Of course, I lost the few hundred dollars I put in. Here's why what I did was super risky: I didn't diversify or consider asset allocation.
Asset allocation is how investments are put together based on the inherent risk of each asset class. I only bought single stocks; I didn't buy any other kind of asset to balance the risk. Then, all the stocks I bought were within one sector: the financial sector that would experience a severe downturn in 2008.
Today, I still risk buying single shares of companies, but I only do that with a small fraction of my investments. My asset allocation and diversification are on point because the great majority of my investments are in ETFs and index funds, so taking this kind of risk fits into my overall investment strategy.
Investing Money You’ll Need Soon or Investing too Much
Having a cash reserve, like an emergency fund, can feel like a missed opportunity in a bull market. Why have all that cash lying around earning nothing when the market is popping the fuck off? But a cash cushion is important and part of being overall financially healthy.
When you put your money into an investment, you're delaying using those funds in the present for use in the future. This is one of the main principles of investing and the reason why it's important to find the right equilibrium between what you invest for the future and what you need to meet your needs while also having enough on hand in an emergency.
If you're constantly stressed and on the brink of going into debt, you might need to allocate more funds for present use. This could be a short-term fix while you figure out the long-term solution to max out your investments while meeting your current needs.
Investing in Things You Don’t Understand
“Don’t invest in things you don’t understand.” This was a principle I learned at the wealth management and financial planning firm I worked for. It’s solid advice. If you can’t understand how something works, you shouldn’t invest your money into it. It’d be like seeing a machine, not knowing what the machine does, and then sticking your arm into it. Probably not wise. The same goes for investing. The good news is, when it comes to the fundamentals of investing, you have options.
What do you do when you want to learn more about something? Personally, if there is a subject I’m curious about, like lucid dreaming or how to create a sellable business, I try to read books on the subject. Not only do I learn best by reading, I know that for a book to get written, the author also has to prove to their publisher that they know what the fuck they’re writing about. And then, the book gets read by multiple editors and fact-checked, which is the exact opposite of what happens when a teenager goes on Tik Tok and tries to explain how to short a stock.
And for me, sometimes I have to read about something from many different voices before I fully grasp it. For example, with cryptocurrency, I read explainer after explainer and listened to podcast after podcast before I understood the concept and felt comfortable investing.
And yes, there have been times where I didn’t understand how something worked and didn’t invest. I’m going to give you an extreme example I heard about recently. I read about a woman that invested most of her life savings through a leveraged tool called options. She did it with the encouragement of a friend, and she nearly lost everything. If she fully understood options, she would have learned this fundamental of a leveraged investment: you have the potential for accelerated returns, but you also have the potential for accelerated losses.
Attempting to Time the Market
The internet is a flood with “buy the dip” memes. Buying the dip refers to purchasing an investment or buying into the market when the price is going down with the hopes of selling it high.
Unfortunately, timing the market is not only extremely difficult, but it also kills your potential returns. For one, you can only know when the market has dipped in hindsight; so any assumptions one is making about the dip in real-time is speculation. Also, do you really know that you will pull the trigger during a market downturn? It's easy to say you will, but harder to do it when you see red and you're emotional. Lastly, when you stay out of the market, you're losing out on gains.
The opposite of buying the dip and the investment strategy that the great majority of investors industry professionals support is called dollar-cost averaging. The name is lackluster, but the strategy is gold. Dollar-cost averaging is buying into the market or investment at regular intervals. For example, contributing ten percent into a retirement account with each paycheck, regardless of what the market is doing.
Unclear Goals
The two of the most common questions I've heard folks ask about investing are, "How should I invest my money?" or, "What should I invest in?" The answer is always the same: it depends. It depends on what the money is for/when you need it. Once you know what the money is for and when you need it, like for retirement in forty years or a downpayment in ten years, it's much easier to know how to invest it.
Before you haphazardly jump into investing, figure out your goals and your timeline for achieving them.
The Takeaway
When you begin investing, something you should understand is that mistakes are part of the process. Knowing what mistakes you may make when they occur and how you can avoid them will help you find success as an investor.
Succeeding as an investor does not happen overnight; however, you can see gains with time, effort, and perseverance. Also, by taking it slow and learning along the way, you can begin to build a portfolio that provides you with many returns over time. Keep this in mind as you move forward with your investing efforts. Being informed will help you make smart investment moves now and down the road.