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7 Common Investing Mistakes and How to Avoid Them
In 1720, Isaac Newton made a fatal investing mistake: he sold off his safe investments and bought shares in the South Sea Company. It had jumped eightfold in the preceding months, and he wanted to get in on the profits. Unfortunately, the market turned rapidly, and by the end of the year, Newton had lost most of his investment.
This tale of Newton’s investing mistakes, exactly 300 years ago, comes from this wonderful article by Thomas Levenson in The Atlantic. The article makes the astute point that people have been making the same core investing mistakes since the dawn of time: lack of diversification, letting emotions drive your choices, not enough knowledge, trusting fraudulent “experts,” and so on.
The mistakes Newton made when considering whether to buy into the South Sea Company are the same mistakes people make today when making decisions about retirement savings or about where and how to invest. Here are seven common mistakes that are just as present today as in 1720, and how to overcome them.
Waiting too long to start
The most powerful ingredient for most investments is time. The longer you have your money in long-term investments, the more powerfully your money will grow. Putting $1,000 into an investment that returns 7% annually gives you $1,967 after ten years, which seems great until you realize that the same investment over 20 years gives you $3,870, and over 30 years? You’ll wind up with $7,612.
What’s the solution? Sitting around for a few years until the situation is perfect for investing will cost you a lot of money. Don’t wait for the ideal opportunity — start now. Go sign up for your retirement plan today. If you’re thinking at all about bumping up your contributions, do it today. Don’t wait for the “perfect” moment that won’t ever come.
Not diversifying investments
Once you understand a particular investment, there’s a strong temptation to put all of your eggs in one basket. You know what you’re getting, after all. The problem is that putting all of your money into one investment can lead to absolute disaster if that single investment fails. If all of your money is in shares of one company and that company fails, you’ve lost all of your money. It’s best to spread that risk around, at least a little.
What’s the solution? Put your money into more than one investment — ideally, spread across many investments. This means that if one of them collapses, you don’t lose all of your life savings. The easiest way to do this is to buy index funds or put your retirement savings into a target retirement fund within your retirement account. Here’s why a target retirement fund is a great choice for retirement savings. Consider diversifying even further and invest in things like real estate, bonds and cash.
Letting emotions control investing decisions
Most investors know that feeling of nervousness in your gut when you realize an investment is dropping in value or that sense of worry that you’re missing out on big gains. Those are emotional responses, not rational ones. We’re wired to see things and respond to them, even though a quick response often isn’t the best choice. This is particularly true when it comes to investing.
What’s the solution? Figure out a diversified investment plan and stick to it, no matter what’s happening. There will be moments when certain investments rise in value rapidly, and other times where investments drop in value rapidly. Don’t respond to them. Stick to your plan. In fact, don’t even watch the day-in-day-out investment news at all.
Not knowing enough about the businesses that you’re investing in
One of the mantras of investing in individual businesses is to know that business well. This is great advice for small business owners, but the advice becomes less important to small-scale investors. We’re often not privy to all the ins and outs of publicly traded companies, and institutional investors can react much faster to changes than we can.
What’s the solution? If you’re an entrepreneur or an angel investor, know the business well. If you’re not, diversify your investments wider so that a smaller and smaller portion of your money is in any one individual company. A good choice is to buy a broad-based index fund, which includes a small portion of many, many individual companies. That way, you’re trusting the overall market — the concept of human industriousness and ingenuity — and not an individual company.
Sometimes, you’ll find that your investment is underperforming another investment over the past few years, and there’s a temptation to jump ship. That investment is getting 9% a year and you’re only getting 7%, so why not jump? This is where the idea that past performance might not indicate future returns becomes important. An investment that does better than yours over the course of the past few years is one that very well may do worse than yours over the course of the next few years, balancing the two out over the long term.
What’s the solution? If you’re feeling impatient and want big numbers in your investment accounts sooner rather than later, don’t alter your investment plan. Instead, find ways to increase the amount you’re investing by making small lifestyle changes. There are many simple frugality steps you can use that have minimal impact on your life while trimming your monthly bills significantly. Apply those, then bump up your retirement and investment contributions. Frugality, when done smartly, can make us feel better about our life, too.
Trying to time the market
There’s a strong desire in many people to try to “time the market” by identifying when the perfect moment to sell high and the perfect moment to buy low is. This seems like smart investing, except that it’s almost impossible to do in the complex investment world of today. We almost always miss the top and the bottom of the market, and missing it by very much at all ends up costing us more than we’d ever gain.
What’s the solution? Stop watching the day-to-day financial news. It’s fine if you’re an institutional investor or a day trader, but for most of us, the day-to-day financial news is just noise. It comes out far too late for us to really do anything useful with. Stick to the plan.
Buying and selling too often
In non-retirement accounts (and some retirement accounts), buying and selling investments comes with a fee. You have to pay a small fee to sell and a small fee to buy more. Doing this too often can eat rapidly into your investment gains. Even if you believe you’re jumping to “better” investments, those gains are often devoured by fees unless you’re moving large amounts of money.
What’s the solution? Invest regularly, but once the money is in your account, don’t move it around. You can do this by having a strong investment plan that you believe in and stick to, one that doesn’t involve many changes. If you decide to rebalance things, don’t buy or sell things — instead, just change how you’re contributing for a while. If you want to own more stocks, change your contribution so that you’re buying more stocks going forward.
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