How to Avoid the Ten Most Common Investment Mistakes
A great deal of money can be earned in the financial markets, although private investors can just as easily suffer painful losses. This is why you should avoid these ten typical investment errors.
1. Following the Herd
Many private investors tend to pick up products that are currently popular. These are often overpriced, however, and already past their peak returns. The same is true for market prices that are rising sharply or dropping abruptly. Investors buy when the general level of confidence is high and sell as soon as there are losses. Most people are a step behind the market on this, sell below value, and buy overpriced. The herd instinct can also lead to speculative bubbles on the exchange that burst sooner or later. So it is a better idea for you to make countercyclical investments, which go in the opposite direction of the herd.
2. Inadequate Diversification of Risk
You probably have personal favorites on the exchange or intuitively prefer products from your home market or companies that you know – a typical investing mistake. What makes this dangerous is the high concentration of individual securities as well as the lack of distribution across asset classes. So you should be sure to add securities from different areas to your portfolio and thus distribute your assets. This diversification significantly reduces risk.
3. Fees Too High
Fees can chip away at profits. Financial institutions require money for accounts and safekeeping accounts as well as for transactions. Be sure to compare them. Fees are also charged for products such as funds and derivatives. To save money, it is worth avoiding particularly expensive products and looking for cost-effective alternatives. For instance, a passive fund may be more attractive than an active one over the long term. This is because significantly more costs are incurred by a manager-administrated fund.
4. Frequent Buying and Selling
Getting involved is good, but too much involvement can backfire. In order to get the largest returns possible, securities are hectically bought and sold based on price fluctuations or news about companies. In hindsight, though, some media reports turn out to be much ado about nothing. The large profits desired fail to materialize. Instead, transaction costs weigh down the portfolio. Investors end up paying for their rash actions. A better idea is for you to focus on long-term investments.
5. Cashing in Profits Too Early
A bird in the hand is better than two in the bush: this saying only applies to the financial markets to a certain extent. People who are eager to cash in their profits can sometimes miss out on additional returns because they sell equities that are performing well too soon. With a little patience, even more could be possible. You should allow your profits to keep accruing as long as the prices are trending upward and there are no signs of a turnaround.
6. Holding onto Losers
Holding onto lossmakers is particularly counterproductive when combined with taking profits too early. Some people insist on holding out and keeping equities whose prices have fallen until they have reached their original value again. What they forget, though, is that they could use the money they would receive from selling to buy a better investment that brings larger returns. So accept your losses – especially double-digit percentages – and move forward by focusing on new securities.
7. Overestimating Yourself
Returns of 20 percent and more sound tempting. So many private investors rely on their gut feeling or expertise and risk too much. Examples include portfolios with few individual stocks, or with many risky investments. Trading is no walk in the park, though. You can either devote a lot of time and patience to learning how to do it, or leave it to a professional with a well-diversified investment fund, for instance.
8. Deviating from Your Own Strategy
It is important to be committed to your investment strategy, once selected. Despite this, a common investing error is when private individuals are tempted by promises of high yields and they deviate from their strategy. With higher return expectations, however, they are also taking on more risk – in some cases, more than their living circumstances will permit. The composition of a portfolio changes automatically over time because equities generate higher yields than other investments, for instance, and thus become heavier over time. Those who want to stick to their risk profiles should thus adjust their portfolio once a year based on their strategy.
9. Not Wanting to Take on Risk
Particularly during times of negative prime rates, fixed-interest investments hardly continue to generate returns. Anyone who still insists they do not want to take on risk is making a serious investing mistake. They are missing out on potential returns from other investments on the one hand, and making very one-sided investments in debt instruments, such as bonds. The lack of diversification then creates more risk despite their good intentions. A better idea is for them to broadly diversify their assets and invest some of their portfolio into funds or equities.
10. Following Insider Tips
Investors who blindly follow stock market gurus or trading systems are often left bitterly disappointed when their strategy falls short. Alleged insider tips should be particularly avoided – for instance, when stock is billed as ideal for beginners. Such advice often amounts to empty promises and ends up burning a hole in your pocket.