It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.
You don’t have to be incredibly smart to be a good investor. The steps you need to take to invest well are actually fairly simple.
In fact, one of the most powerful things you can do to get ahead is simply avoid making big mistakes. Good investing is less about making great investments and more about not doing the things that trip up most people.
Here are seven of the biggest, most common investment mistakes people make, and what you can do to avoid them.
Mistake No. 1: Not Saving Enough
While the sexier aspects of investing get most of the press, there’s no part of your investment plan that’s even remotely as important as your savings rate.
Jumping from a 5% savings rate to 10% can cut 15 years off your working life. Bump it up to 20% and that’s another 14 years sooner you’ll be free.
There’s no other investment decision that has that kind of impact.
Unfortunately, most people aren’t saving enough. The average U.S. citizen saves about 5.4% of his or her monthly income, according to the Federal Reserve Bank of St. Louis. Even assuming all of that money is going toward retirement (unlikely), that translates to a 66-year working career.
So before you even think about anything else, make sure you’re either already saving enough or you have a plan to get there over time.
Mistake No. 2: Not Automating Your Savings
If your savings aren’t happening automatically, you likely aren’t saving enough, and you probably feel more stressed about it than you should.
Automating your savings does two huge things for you:
- It ensures that you’re consistently meeting your savings goals, month after month.
- It allows you to stop stressing about how you spend the rest of your money, since you know your savings goals are already handled.
You can automate savings to your 401(k) or other company plan through payroll deductions. And you can automate savings to an IRA or other investment account by linking it to your checking account.
Either way, that automation will ensure that you stick to your plan every single month.
Mistake No. 3: Leaving Free Money on the Table
You’ve undoubtedly heard this one before, so I’ll keep it short: If you’re not taking full advantage of your 401(k) employer match, you’re giving away free money that you’ll never have the chance to get back.
If your workplace matches the first 6% of your 401(k) contributions, make sure you’re contributing at least 6%. If they’ll match up to 10%? Find a way to hit that 10%, and congratulate yourself on the raise you just earned.
Mistake No. 4: Paying Too Much
There’s an easy way to predict how well an investment will perform going forward, and you don’t need a Ph.D in finance to do it.
All you have to do is look at the price.
Research has shown that cost is the single best predictor of future investment performance. The less an investment costs, the more likely it is to produce positive returns.
Unfortunately, most investors have no idea how much they’re actually paying, because most of the fees are pretty well hidden. Management fees, trading fees, taxes, and the like are all either automatically deducted from your investment account or are only charged long after they’re incurred, meaning that you almost never see a bill for the investment decisions you’re making.
That makes it easy for financial companies to charge more than they should. And every extra dollar they charge is a dollar that can’t be used towards your biggest goals.
Minimize your fees and you’ll be well on your way to investment success.
Mistake No. 5: Investing Too Aggressively
When the stock market is going up, as it has for the last seven-plus years, there’s a strong urge to invest more aggressively than you otherwise would.
In fact, there’s research showing that investors tend to put their money into investments that have performed well recently. Unfortunately, that same research shows that, in most cases, those same investments end up under-performing going forward.
I have no idea what the stock market will do in the near future (no one does), but I do know that being too heavily invested in stocks has some big potential negative consequences:
- If you will need the money relatively soon, a big loss can be devastating.
- Even if you don’t need the money for a long time, a big loss can scare you away from investing in the future, which can have a negative impact on your ability to build wealth and eventually retire.
In other words, now is a good time to re-evaluate your investments and decide whether you’re investing too aggressively. A good rule of thumb is to expect that you could lose up to 50% of the money you have in stocks in any given year.
If you’re comfortable with that given your current investment plan, great! If not, it might be worth getting a little more conservative.
Mistake No. 6: Investing Too Conservatively
On the flip side, many people don’t have enough money in the stock market.
A recent study showed that only 55% of adults in the U.S. owned any stocks at all. That number is even lower for younger investors.
While the stock market carries plenty of risk in the short term, it’s also one of the best ways to grow your wealth over the long term. Without the returns it provides, you’ll be hard-pressed to save enough to eventually be financially independent.
And the truth is that over the long term, the stock market has always gone up. While that doesn’t guarantee anything where the future is concerned, it does mean that the odds are in your favor if your time horizon is long enough.
Mistake No. 7: Bailing Out
For indeed, the investor’s chief problem—and even his worst enemy—is likely to be himself.
Investing is hard. Not because it’s complicated (it’s not), or because you need a financial degree to do it right (you don’t).
It’s hard because it’s emotional and because there’s a lot you can’t control.
No matter what you do, you can’t force the stock market to keep going up. It will fall, sometimes significantly, and your account balance will drop in the process.
That’s not easy to watch. It’s not easy to see the money you’ve worked so hard to save, the money you’re relying on to fund your future goals, disappear so quickly.
In those moments, the urge is to “do something.” You want to protect your savings, so you spring into action. You may not know exactly what to do, but you can’t just sit back and watch your money go away, right?
The hard truth is that you can’t protect your money at all times. But you can protect it over the long term by choosing a plan and sticking to it, even when that’s hard to do.
In almost every single case, the best thing you can do when the stock market is falling is nothing.
Selling out and waiting until it’s “safe” to get back in is one of the great destroyers of wealth. It may feel like the right decision at the time, but it will almost certainly lead to you having much less money in the end.
Pick an investment plan you feel good about and stick with it through thick and thin. If you can do that consistently, you will be happy with the results.
Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.