This post explores the common mistakes faced by traders and investors. I am putting together a series of posts in the Getting Started series to help new investors, but this post holds true for seasoned investors as well – as we tend to forget some of the basics and get caught in the moment. It is always important to keep track of the following points while investing in order to avoid repeating these mistakes.
1. Lack of understanding: Jumping into an investment without understanding it is one of the most common mistake. Every profession goes through years of training and practice, yet people gamble their life savings away by jumping into the stock market without educating themselves. Trading the hot stocks that you hear about without understanding anything about the business is guaranteed to lose you money. Another problem adding fuel to the fire here is that the media and “experts” pass on their opinion portraying it as factual information.
2. Timing the market: Timing and beating the market consistently is probabilistically unlikely. Day trading and high-frequency trading simply does not work for the individual investor because the odds of beating the institutions are minimal, if not zero. Institutional investors always have more data (or at the very least, data before you do – which could even be by a fraction of a second), faster computers, better trading strategies which will always help them come out on top.
Remember that there are two parties to a trade. For every trade where you are buying and are sure that you are timing it right, there is another person who thinks that getting out at the moment is the best course of action. What one needs to consider is this: “What information does the other person have that I dont?”
3. Instincts and Emotions: Trading with instincts and emotions is one of the top reasons for the irrationality of the masses. Bringing emotion into your investing mechanism could result in huge losses. Investors should never get attached and fall in love with particular stocks and even your best performer should be a candidate for selling if something fundamental changes where the investment does not make any sense.
4. Invest in what you know: ‘Invest in what you know’ has become a common theme in the investing world, which has also been perpetrated by the media. I disagree with this approach. Investing in a company just because you “know” their product doesn’t mean it can be a great investment. For example, I have heard many a times from gamers tending to think that a Xbox and PlayStation are fantastic products and are buying Microsoft and Sony are the way to go. However, during the life of Xbox 360, Microsoft was losing money on every console sold. Gaming has never been a breadwinner for Microsoft. Similarly, the Sony stock SNE has had a terrible run over years. Sony is a huge conglomerate, and even with its hands in so many pies, SNE has returned -17.5% in the past 5 years and -47% in the past 10 years.
Similar argument holds for geographical investments. Investors simply tend to stay invested in their own country instead of diversifying with investments in other countries.
5. Patience: Time is one of the biggest, if not the biggest factor in investing. An investment in a solid company which has a great business producing profits year-in-year-out will be your star performer. All you have to do is simply sit back and wait for your returns to compound over time.
6. Not sticking to the plan: Sometime also termed Performance chasing (although I dont like using that term for this issue) and shifting focus to the current theme that seems to make sense momentarily and abandoning your original plan to jump on the latest bandwagon – this approach can also incur losses in an investor’s portfolio.
Fees add up. A lot. If investments fees arent kept in check, returns can be diminished by thousands of dollars over a lifetime. It is for this reason that I discourage using mutual funds and instead use low cost index ETFs for better returns.
What do you think of the list above? Are there any other common mistakes that I have missed? Share your thoughts in the comments below.