Nobody's perfect. We are all going to have our wins and losses, especially when it comes to investing. But some of the mistakes you might make when trading stocks are actually pretty common and by no means reserved exclusively for you alone. In fact, the majority of investors make many of the following mistakes.
The good news is that most of these mistakes can be avoided simply through awareness. We will take a look at the 10 most common mistakes and identify ways in which you may be able to stop the habits—or even turn them to your advantage.
- When investing, it's important to know some common pitfalls so you can be prepared to avoid them.
- The biggest investing mistake you can make is not investing at all since you lose out on the power of compounding interest.
- It's also important to keep your investments diversified and avoid investing in stocks you don't understand.
- Other mistakes include expecting too much, risking more than you can afford, and failing to research before investing.
1) Not Investing
Of all of the mistakes that a beginner investor might make on their investing journey is not investing. Retirement is expensive, and unfortunately, most of us won’t be able to save enough without a lot of help from the stock market.
Imagine saving $250 per month from the age of 25 until you retire at age 65. If you were to keep that money in a bank account that does not accumulate interest, you would have just $120,000 by the time you retire. Unfortunately, that’s not likely to last you very long.
However, imagine if you had invested that money in the stock market and it was allowed to compound, meaning you earned interest on your interest. According to the Securities and Exchange Commission (SEC), the stock market has had an average annual return of about 10%.
With that, your $250 per month contribution would result in you having more than $1.4 million by the time you retire. The same amount of money contributed throughout your life would be significantly higher by investing in the stock market instead of a non-interest-bearing account.
2) Buying Shares in a Business You Don't Understand
Another mistake is when investors gravitate towards the latest "hot" industry but know little or nothing about the company or industry. Without proper research, you stand to lose your hard-earned money, particularly if you don't know the company's financial viability. However, when you research and understand a business and its industry, you have a naturally built-in advantage over most other investors.
When you invest outside your knowledge base, you may not know the subtleties and complexity of the company in question. This is not to say that you need to be a gold miner to invest in gold mining companies or a medical doctor to invest in health care, but proper due diligence is critical, or consider hiring a financial advisor to help.
3) Putting All of Your Eggs in One Basket
When you put all of your eggs into one investment, one negative event could damage your entire portfolio and, therefore, your financial future. Diversifying your portfolio helps reduce your risk so that if one of your investments underperforms, it doesn’t necessarily impact your entire portfolio.
You can diversify across asset classes, such as investing a portion in stocks, bonds, and real estate. If the stock market crashes, for example, the bond market might perform well, helping reduce your losses from equities. Another way to diversify is to invest in multiple companies within one industry. You can also buy several sector funds in which each fund focuses on one industry, such as technology or financials.
Investing in index funds, mutual funds, or exchange traded funds (ETFs) is an easy way to diversify your portfolio through just one investment.
4) Expecting Too Much From the Stock
Another investing mistake is expecting too much return from a stock, which can be especially true when buying penny stocks. Low-priced stocks might appear to be lottery tickets, allowing a $500 or $2,000 investment to become a small fortune. However, there is a significant risk of loss with penny stocks, and investors that expect a small, underperforming company to outperform its peers might be disappointed. It's essential to have a realistic view of what to expect from the performance of the company's shares.
Review the past performance of the stock you are interested in and decide based on the company's financial performance as well as the stock's historical trends and gains. While past performance is no guarantee of future results, it can be a good starting point since it provides insight into the stock's volatility and trading activity.
5) Using Money You Cannot Afford to Risk
When you use money that you cannot afford to risk, your emotions and stress levels get heightened, which can lead to poor investment decisions. When evaluating stocks, consider your risk tolerance, which is your willingness to lose a portion or all of your original investment in exchange for higher returns. When determining your risk tolerance, evaluate the securities or asset classes you're comfortable with, such as growth stocks versus bonds.
Don't invest money you can't afford to lose, such as your rent money or emergency savings. Conversely, you will make much better investment decisions by investing money that you can afford to risk.
6) Being Driven by Impatience
Another investing mistake is a lack of patience. If you're investing for the long term, stocks may not experience the desired gains right away.
If a company's management team unveils a new strategy, it may take months or several years for that new approach to play out. Too often, investors will buy shares of the stock and then immediately expect the shares to act in their best interest.
For example, the broader S&P 500 index has given an average annual return of 9.01% between 2000 and 2021. This includes five years when the index saw negative returns, including the Great Recession in 2008, when it was down by 36.5%.
What often makes investing profitable is the magic of compounding. Compounding takes time to really work, which is why those who start saving for retirement when they’re young often see the best returns.
7) Learning About Stocks From the Wrong Places
Getting stock tips or information from the wrong sources is another common and costly investing mistake. There is no shortage of so-called experts who are willing to offer their opinions while presenting them as if they are educated and endlessly correct.
Even stock analysts that work for investment firms get it wrong and usually have a solid grasp of the company and the industry they cover. In other words, even if they're qualified to render an opinion, they can still be wrong.
Generally, government-backed sources and nonprofit organizations are a good place to start for general investment advice or guidance. You could also consult a financial advisor to guide you through the process.
Not even the most experienced and successful investor can predict the future. If an investment professional guarantees a certain outcome on your investment, consider it a red flag.
8) Following the Crowd
Following the crowd or following the herd is another investing mistake since it often doesn't involve research but instead mirrors what other investors are doing. Many people only hear about an investment after it has already performed well. If certain stocks double or triple in price, the mainstream media tends to cover those moves as hot takes.
Unfortunately, by the time the media gets involved, it is usually after the stock has reached its peak. At that point, the investment is likely overvalued. Nevertheless, television, newspaper, internet, and radio coverage can push stocks higher into excessively overvalued territory.
One example of this trend is the 2021 hype around the GameStop stock. By the time the surge reached the mainstream media, most of the gains had already been made. Those investors who got in too late likely ended up losing money.
9) Averaging Down
Averaging down can be a costly mistake when investing. Averaging down is typically used by investors who have made a mistake already and need to cover their error. For example, if they bought the stock at $3.50, and it drops to $1.75, they might make that mistake look less awful by purchasing more shares at the lower price.
The result is that now they've bought the stock at $3.50, and more at $1.75, so their average price per share is much lower, making their loss appear far smaller than reality. However, by buying more shares that have dropped in value, you're sinking more money into a losing trade, which is why averaging down can also be considered throwing good money after bad.
Conversely, an effective strategy is to average up, which is when you purchase more shares once the stock price has risen, confirming that you made a good call.
10) Doing Too Little Due Diligence
Not performing due diligence when investing can be a costly mistake. Venture capitalists and investment funds perform due diligence regularly to ensure their investments are worthwhile. With a proper due diligence strategy that is predetermined, organizations are more likely not to be blindsided and make well-evaluated investment decisions, according to the Global Impact Investing Network.
An individual investor should perform proper due diligence, especially with highly speculative and volatile penny stock shares. Typically, the more due diligence, the better your investing results. If you've reviewed the company, including any warning signs and potential risks, you're much less likely to be negatively surprised by an event.
The Bottom Line
Ideally, you won't commit too many of these common errors. However, investors will make some of the mistakes that we've discussed. Luckily, you can channel your inner teenager and learn from your mistakes. In fact, most people learn more from their losses than they do from their gains.
Given enough time and experience, you will likely be in a better and more profitable situation. Ideally, you want to phase out the common mistakes quickly enough so that you still have funds remaining to invest.
Frequently Asked Questions
What are some beginner investing mistakes?
Not investing is a common mistake. It's important to start saving and investing early and use compounding interest to grow your wealth. Also, following the crowd is another investing mistake since it doesn't involve doing the proper research.
What are emotional investing mistakes?
Averaging down can be costly, which is when investors buy additional shares in a stock that's already losing money. Also, impatience is a common mistake. Investing in stocks may not yield the desired gains right away.
What are the most common investing mistakes?
Using money that you cannot afford to risk heightens your emotions and stress levels, leading to poor investment decisions. Also, learning about stocks from the wrong sources, such as your coworker's stock tips, is a common investing mistake.