How to overcome common investing pitfalls(Read article summary)
Like anything else, investing carries with it some common foibles that can easily be avoided with the right game plan.
Investors will make mistakes; it’s human nature. No one has a crystal ball. But we do have biases, ill-conceived notions and emotional roadblocks that can affect our investing decisions.
These notions prevent us from taking a cool-headed approach to investing. Instead we make rationalizations or are beset by misapprehensions. Some investors even tell themselves outright lies that end up sabotaging their long-term investment plans.
Here are five ways we humans can avoid common investing pitfalls while trying to invest for the long-term:
1. Don’t rush into a ‘big opportunity’
When investing, there is no such thing as that “one big opportunity.” The current price of gold, the latest tech stock, or even your brother-in-law’s burgeoning carwash business is never a sure thing. So don’t ever feel you have to jump on an opportunity now to make a profit. You do eventually have to move off the dime and make something happen, but no one is going pull off a lifetime’s worth of growth with one or two big hits. Successful investing needs to be carried out over time.
In a dynamic economy like ours, opportunities tend to pop up with some regularity, even during recessions. In fact, some of the best opportunities may present themselves during a recession, because the markets are depressed and stocks tend to be “on sale.”
Now that doesn’t mean that there aren’t particular times in the economic cycle when certain opportunities may be more or less robust. The prevailing market conditions will dictate how often these opportunities present themselves. But they will, and do, appear many times over an investor’s lifetime. It just may take some education and some reliable professional help to recognize when to act on them.
With patience and persistence, you’ll uncover enough good opportunities over time to build a substantial, successful portfolio. So rather than seek out the occasional big idea or hot tip, set up an investing methodology that you can use to build your portfolio steadily over the long run.
2. Focus on percentages, not dollar amounts
A common mistake that many investors make is to look at the dollar amount their account has lost or gained each month, rather than at the percentage change. For example, let’s take an investor, Ken. After reviewing his monthly financial statement, Ken calls his financial advisor in a panic. His stock portfolio is down $5,000. While that certainly is nothing to cheer about, it’s important to keep the loss in perspective.
If Ken’s account was $200,000 at the beginning of the month, the $5,000 loss represents a 2.5% decline in value. A one-month decline of that size is well within the range of normal stock market gyrations. Also, if Ken were to compare his portfolio to that of the Standard & Poor’s 500 Stock Index, which was down say 5% during that same month, he would find that he is actually doing quite well, comparatively. So, unless Ken decides to sell his stocks, he hasn’t really taken a loss, because by the next month, assuming he stays invested, his stock portfolio could go up 3%.
Many investors don’t see the bigger picture. If they did, they would realize that focusing strictly on a dollar amount is almost always a futile exercise, and that a 3% to 4% hit to their portfolio should not necessarily be a cause for concern. When it comes to your investments, the only way to make an intelligent, apples-to-apples comparison is to use percentages.
3. Leave your ego at the door
Often investors let their pride get in the way of making sound investment decisions, particularly when they are dealing with a salesperson who is well-trained in appealing to investors’ egos to make a sale. For instance, a broker may push you to make a snap decision on a “great deal,” by mentioning that others have already done so, and if you don’t act now, you will lose out on the opportunity. But in reality, the move might not be in your best interest.
That’s why when it comes to investing, it’s a good idea to check your ego at the door and instead focus primarily on your lifelong financial plan. When done right, investing is not a competition between clear-cut winners and losers — it’s a long-term process that requires a series of well-planned, unbiased decisions.
4. Don’t try to make up for lost time with aggressive investing
Falling behind on one’s long-term investment goals can certainly be a cause for concern. But you don’t want to compound the problem by adjusting your investment strategy inappropriately to try to make up for lost time. If your lifetime goal is to average, say, 6% to 7% on your invested money, you have a decent chance of achieving that goal with a practical, persistent investment program. But if you’ve fallen behind on your saving and suddenly decide you need to shoot higher to achieve your goal — say, 15% per year — you are probably headed for trouble.
That’s because consistently earning double-digit returns over many years is extremely unlikely. In fact, the higher your investment goals, the greater the risks you’ll have to take to achieve those goals. You may have to buy stocks that are more speculative or invest in high-yield, high-risk bonds that are more likely to face default. The more risks you take on as an investor, the greater your potential gain will be, but also the greater your potential loss.
A better way to play catch up with your investment program is to spend less and save more, slowly pumping up your investment portfolio over time. You may also consider staying at your current job past age 65, or finding work as a consultant or contractor after you retire. Even taking on a part-time job can help you continue to add to your nest egg.
Still, the best way to assure that you’ll have the money you need to finance a comfortable retirement is to begin your investment program as early in life as possible and continue to contribute to your portfolio for as long as you continue working.
5. Learn from your mistakes
We all make mistakes, and as an investor, you will too. But if you can learn from those mistakes you will inevitably be a better investor for it.
Investing magnate Sir John Templeton had some very succinct but powerful advice for investors: “The four most dangerous words in investing are ‘this time it’s different.’” Those investors who pride themselves on being immune to self-deception often keep at the same old game: a momentum stock here, an errant tip there. But investors who are able to see the error of their ways and walk away from a shot-in-the-dark deal will likely be more successful over the long haul.
The bottom line
In the end, putting aside ill-conceived notions and emotional roadblocks can help you make better investing decisions. By following these tips, you can ensure that you take a rational, patient and persistent approach to investing that will serve you well in the long run.
This article first appeared at NerdWallet. Learn more about Ken Weber on NerdWallet's 'Ask an Advisor.'