5 Mistakes Investors Make and How to Avoid Them
The most obvious clue that something is wrong with your investment strategy is that you are losing money. A loss of more than 10% on any one investment may be a signal that you have a problem. Believe it or not—when it comes to investment losses—most of the time, our worst enemy is ourselves. Following are five common mistakes made by individual investors, along with some tips for avoiding or correcting them.
Mistake #1: Not Selling Losing Stocks
Failure to get out of losing positions early is one of the biggest mistakes investors make in managing their investment accounts. The reasons investors hold on to losing stocks are typically psychological. For instance, if you sell a stock after sustaining a loss, you might blame yourself for not having sold sooner. Others convince themselves that a losing stock will come back one day and are reluctant to “throw in the towel.”
To keep your losses small, you need a plan before you buy your first stock. One rule of thumb to keep in mind is if you lose more than 10% on any one investment, consider selling it. You can put in a stop loss order at 10% below the purchase price when you buy the stock, or you can make a mental note to watch it over time. The main point is that you should take action when your stock is losing money. Even if the company looks fundamentally strong, if the stock is going down (for reasons that may not be immediately apparent), consider using the 10% rule.
Mistake #2: Allowing Winning Stocks to Turn Into Losers
For many investors, it seems as if they can’t win no matter when they sell. For instance, if you sell a stock for a gain, you may be left with the lingering feeling that if you had held it a little longer, you’d have made more money. On the other hand, if you make a handsome profit on an investment only to watch it plummet in value, you no doubt feel helpless to stop the loss—and victimized by the market’s fickle ways. When faced with this painful situation, some investors may hold out hope that their favorite stock will eventually rebound to its previous highs.
If you have a winning stock, you probably think it’s crazy to get out too early. That’s why you might want to adopt an incremental approach to selling winners. If, for example, your stock rises by more than 30%, consider selling 30% of your position. By selling a portion of your gains, you satisfy the twin emotions of fear and greed—and perhaps more importantly—you take an active role in maintaining an appropriate balance in your investment mix by not allowing your portfolio to become underweight or overweight in any one asset class.
Mistake #3: Getting Too Emotional About Stock Picks
The inability to control their emotions is the main reason why most people make mistakes when investing. In fact, becoming too emotional about investment decisions is a clue that you could be on track to lose money.
A common problem----especially for those who have tasted success in the market—is overconfidence. Although some self-confidence is necessary if you are going to invest in the market, allowing your ego to get in the way of your investment decisions is a dangerous thing. The most profitable traders and investors are unemotional about the stocks they buy. They don’t rely on fear, greed or hope when making trading decisions; instead, they look only at the facts—technical and fundamental data.
Mistake #4: Investing in Only One or Two Stocks
One of the problems with investing directly in the stock market is that most people don’t have enough money to maintain a properly diversified portfolio. (In general, no one stock should make up more than 10% of your portfolio.) Although diversification limits your upside gains, it also protects you in case one of your investments does poorly. If you can’t afford to buy more than one or two stocks, you have several choices. Or, you can hire a financial advisor to help you manage and diversify your portfolio.
Mistake #5: Not Expecting the Unexpected
Before you get into the market, you should be prepared, not scared. Although you should always hope for the best, you should also be prepared for anything. The biggest mistake many investors make is thinking that their stocks will not go down. It is those investors who are blind-sided by sudden market crashes, an extended bear market, a recession, deflation or any other unanticipated event that could have a negative impact on the market.
While a little bit of fear keeps you on your toes, too much fear can cause you to miss out on investment opportunities. It is the fear of loss that prevents many people from buying at the bottom, and it is the fear of missing out on higher profits that prevents people from selling before it is too late. Typically, fear results from a lack of information. That is why it is important to work with a trusted financial advisor to create a plan based on information and knowledge – not emotions.
There is no assurance that the techniques and strategies discussed are suitable for all individuals or will yield positive outcomes. General risks inherent to investments in stocks include fluctuation of market prices and dividend, loss of principal, market price at sell may be more or less than initial cost and potential liquidity of the investment in a falling market
This article was prepared by Standard & Poor’s Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor or me if you have any questions.