Last updated July 5, 2018In the modern financial world, investing can be a confusing and arcane world to traverse through for the small investor who is just starting to get in the game. In fact, most new investors are handicapping their returns because of misconceptions about the stock market. Luckily, a lot of these mistakes can be easily corrected and fixed. Listed below are three of the most common mistakes every new investor makes and how you can avoid making them yourself.
1. Poor Risk Management
Few investors are correctly managing their portfolio’s risk. The “right” amount of risk an investor should be exposed to heavily depends on their appetite for risk, and when they plan on making withdrawals from their investments. For investments with a shorter time frame (less than a few years), it is generally accepted that a low-risk portfolio composition is warranted. This is because lower risk securities such as bond funds (BND) have very low volatility meaning they’re price does not make as wild swings as something like stock funds (FVINX). A lesser volatility means your investment will likely still be there when the waiting period is over and you are not forced to withdraw at a loss. For investors with a longer time frame, higher risk investments are safe to make if their risk is diversified enough and if held long enough. Highly diversified investments include index funds as they are invested in a broad range of the largest U.S. companies.
2. Blindly Following the Herd
Actively reacting to the stock market’s daily movements can kill an investor. The investor with a diversified portfolio of stocks/mutual funds/ETFs would expect their prices to fluctuate and should not be concerned by stock market movements. The investor would not buy a stock because it has gone up or sell a stock because it has gone down. Benjamin Graham, Warren Buffett’s first mentor, uses the following motto:
“Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.” – Benjamin Graham, The Intelligent Investor
Graham, much like Buffett, likes to keep emotion out of investing as possible and almost every passive investor should certainly do the same.
3. Forgetting About the Fees
Perhaps the least thought of issue but the greatest thief of returns are fees. Fees are especially dangerous because they are more often than not, hidden in mountains of complexly worded documents which goes unread. Even so, fees should never be ignored. Even small differences in fees from one fund to another can add up to substantial differences in your investment returns over time. In one of our previous articles “Why Passive Index Fund Investing Beats Any Mutual Fund”, we go more in-depth explaining how hidden fees have the potential to wipe out nearly half your returns without you even knowing it and how you can save yourself from paying such fees.