Hello everyone! Today I’m really pleased to feature another guest post – today we’ll be focusing in on mistakes easily made by first time investors.
This entry is by Aalia Haris over at the blog The Female Economist, a blog which aims to encourage learning about Finance and the economy amongst women, who remain significantly unrepresented in the sector.
The Wilderness has written a number of articles for first time investors as part of the starting to invest series, and you can read our thoughts on why investment works, understanding some of your options for investment and understanding your risk profile here.
We agreed with the points raised by Aalia on traps that can catch you out when you start out – please enjoy and do check out The Female Economist blog……
Over to Aalia!
When you reach adulthood, all these expenses coming up from all directions catch you unaware. They’re never-ending, and you always feel like investing is something for when things are easier- but they’ll never be! There will always be loans to pay off, rent, bills and insurance to pay for – and those extra things you’re saving up for.
A lot of first-time investors think it’s either too risky or needs too much investment. On the other hand, first-time investors also feel like they could earn a lot of money over a short period of time with short-term investments. These are some of the biggest mistakes that guarantee that you’ll stay out of the marketplace! Here are ten mistakes first-time investors make:
1. Not doing enough research
A lot of investors depend too much on finance news and hearsay. Investors should do some through self-study to find evidence, rather than believing the existence or promise of a certain market trend. So, how do you conduct research? The good news is that every investor has access to the same information you have, with the plethora of reputable and informative websites out there. You just need to know how to utilize it:
- Understand that low stock prices aren’t necessarily going to be good investments
- Don’t blindly follow trends in investments
- You need to understand the company you’re investing in, along with the industry or market to know exactly where they stand.
- A good performance of a company in the past isn’t an indicator that it will do well in the future
- Understand the potential of their product according to existing trends in the industry and customer demand
- Understand their financial position, intellectual property rights and how much they invest in R&D
- Make sure to decide which type of investment would interest you the most
- Recognise that business is changing rapidly with the advancement of technology
- Pay attention to the fees involved!
2. Making Decisions On The Whim Rather Than Logically
A common mistake most first-time investors make is investing out of emotion- impulses, frustration, competition, excitement, jealousy, instead of using logic. They need to understand that risk is part of the deal, and things won’t always go their way. If things don’t go their way, then they need to step back, analyze and decide the next move. Day trading is one of the most riskiest moves first-time investors can make, based on their whims. You can’t involve yourself in day trading without thorough research and understanding of the markets or without a large amount of money for investment. If it goes well for some time, a lot of first-time investors may give into over-confidence, which again, leads to nothing but downfall.
3. Buying individual stocks
Nearly every first-time investor would fall into error by investing into individual stocks. They do it because there’s little investment involved. However, this also means that they’ll be able to buy only a small chunk of the stock in the companies. If you’re only able to afford few stocks, then market fluctuations (which will happen, whether you like it or not) will affect all of them drastically, and you’ll just end up selling the stocks or losing your investment. And don’t forget the transaction fees! A good solution to this predicament is going for an ETF (mutual fund or exchange trade fund) program. With that, you can have your diversification even without paying a lumpsum.
4. Lacking In Diversification
Ever heard the saying, “don’t put all your eggs in one basket”? Because when the basket falls, all the eggs break, and you’re left with nothing. At least if they’re in separate baskets, it won’t affect all of them. It’s the same thing with stocks. You reduce the exposure to any specific risk which may come with market fluctuations. To diversify your portfolio, you can invest in local and international stocks and bonds. So just in case one business or industry you’re invested in doesn’t do well, you’ve got back-up! There are online platforms these days that allow easy access for such trading.
5. Not Having a Plan
It’s not enough to do your research and confidently say, “I know what I’m getting into.” You need to know what you’re getting into for a long time to come. When are you going to pull out? Is there a limit to the amount of loss you can take before you pull out? How much are you willing to invest? If you haven’t asked yourself all these questions, you better hold your horses and grab a pen and paper. Maybe you do have a plan- but you may slip away from it, like a lot of first-time investors do.
So, once you make a plan, stick to it! If you can’t be consistent with your plans, you can’t expect a consistent income. A classic example is going short when the share price seems to be going down and then getting a cold shock when it goes unexpectedly high. You don’t want to be that person! A good solution to avoid this is using stop-loss orders. This can help prevent too much loss. It’s a little tricky to set up the parameters, but it’ll work out better than going in there without a plan and then going into a panic-selling frenzy when things could have been in your favor anyway. Yeah, talk about dropping an axe on your own foot!
6. Ignoring Risk
There’s risk is business. Confidence certainly doesn’t mean that you shouldn’t be prepared for loss, going into it with your “fool-proof plan”. That will turn into a fool “proved” plan instead. Confidence is knowing what to do if you face losses. Alternatively, you can start with low-risk investments and climb up the ladder of higher risks as you gain experience. As you learn more, you’ll come to know that if you want to gain more, you’ll have to risk more.
You’ll have to increase your risk tolerance- that is, seeing your precious money drown- or almost drown on a regular basis. It’s obvious how many people can’t stomach that. If you are looking for something more reliable instead, then you could invest in established firms that are more predictable, rather than volatile markets or start-ups. Other low-risk investments are US Treasury bonds. This still doesn’t mean that there’s no risk. It still requires research, and the precaution of never investing more than you can afford to lose! There are several tools online that could help you gauge your risk profile and find information and insights about different kinds of shares they would be most fit to invest in without higher chances of losing.
7. Not RECOGNISING A Losing Trade
The only way to avoid those losses the risks pose is being able to recognize a losing trade, getting over a small loss and investing in something else. Market indicators help you analyze if a loss is temporary or if it’s going to make you drown with it. First-time investors often hold onto their shares, hoping that a fluctuation in their favor will be able to recoup their losses. Instead, they end up losing everything, having lost the chance to pull out when they could have. To be a successful investor, you need to be whip-sharp and quick at taking action when needed. Again, emotions come into play in this case. Some investors stay in self-denial about the fact that they may have gone wrong. Instead, they stick to their decision in the hope to be proven right. There’s non right or wrong in business. There’s only profit and loss.
8. Buying With Too Much Margin
Margin is the business word for the loan you take from your broker for purchasing securities. These securities are usually the higher cost futures. There’s more to this “free money”, of course. Here, you need to have a solid plan. And a plan B and C. Margin is definitely a way to get a great return on investment, but the losses will be as severe. Then, besides other debts you have to pay back, you’ll end up with yet another debt to pay. It’s just like buying stocks with a credit card. Before going for this option, you need to know all the terms and conditions it comes along and most of all, when you’re supposed to go for a sell-off. You’ll also have to keep an eye out for your positions more attentively, especially with larger gains and losses over a short period of time. If you’re not an expert, you might just end up seeing the brokerage selling your stocks to recover the losses.
It’s not the worst idea to use margin, but make sure you don’t go overboard with it.
9. Thinking Short Term
Remember how there’s this panic and stones-falling-in-the-gut feeling due to stock market fluctuations? With a long-term plan set into action, you’ll know the trends not by days or weeks, but months and years. If you know a pattern is in place, you’ll usually be expecting some seasonal losses or temporary low-revenue months for a company. Stock prices rising and falling would be expected at the end of the day, not something you’ll dread all the time. First-time investors usually have a short-term attitude. They obsessively monitor stocks, and they’re always at the edge of their seats. Thinking long-term will make you aware of the bigger picture, knowing exactly when to pull out your investment. In the longer run, this will give you more money.
Something else that first-time investors almost never do is re-investing what they earn! Certainly, the aim of getting a good return on investment isn’t to throw it away for a shopping spree. You need to let your money grow, so you could use it for your long-term goals. Investing the money you earn, combined with what you started out with, is known as compounding.
10. Making/Following Inaccurate Predictions
Being in the stock market depends a lot on predictions. They’re made all the time, even by experts. That still doesn’t mean that your prediction will be right (even if you spent six months conducting research and really know your facts). Besides company performance, there are other factors to look into as well, like cash flow statement or their balance sheet. Wrong predictions are the Achilles heel of even the most seasoned investors. First-time investors often expect too much from penny stocks or low-priced stocks, based on these predictions. No, your $500 investment will not give you $10,000 in returns like it did for that lucky fellow in the news. A good investor depends the least on chance, and the most on predictions based on facts.
Whereas past performance isn’t necessarily an indicator for future performance, past performance trends can surely help. You can also look out for investments made by competitors. How much do their shares move up or down over a period of time? You need to look at every aspect as you make your plan.
Once again, one of the main reasons people make wrong predictions is emotions- having a “feeling” that something is a good idea, without looking at the facts- or looking at their own cherry-picked facts, convincing themselves that something is worth investing in, when all they could face would be loss. Cure for Alzheimer’s? Yes, it’s a great idea, but will it work the way you’d imagine it would?
You’re All Set!
You learn from your mistakes, but a smarter way is to learn from others’ mistakes. Now that you know all the mistakes you could potentially make, you could very well be on the road to success.
Thank you again to Aalia and thank you for reading.