When I was in high school, I decided to start investing in the stock market. I worked until I had enough money and bought $200 worth of stock in a solar company called SunEdison.
Within two years, SunEdison declared bankruptcy and I lost all $200. To this day, that was the single best investment I’ve ever made.
Alright – obviously, losing all my money was not the best financial investment I’ve ever made. In fact, quite a few of the investments I’ve made since have seen some pretty nice gains *cough Dynalect’s holdings cough* The reason SunEdison was the best investment I’ve ever made was not because of the money I got from it (negative $200 to be precise), but because of what I learned from it.
I learned several things from that experience, the first being that it sucks to own stock in a bankrupt company (SunEdison is currently trading at 4 cents a share). The other (more important) thing I learned was that to succeed in the stock market, you should really avoid making the following mistakes:
Mistake 1: Not planning
“I have always found that plans are useless, but planning is indispensable”
That is a quote from Dwight D. Eisenhower, so you should take it seriously – the guy practically won World War II.
What he means is that although the world is unpredictable and things rarely go as planned, it is still crucial to have a plan to begin with. Although Eisenhower specialized in war, this ideology holds true in just about everything you’ll ever do.
So before making a single purchase, plan your portfolio.
What rate of returns do you want? When do you want those returns by? How much risk are you willing to take? What types of investments do you want? These are just a few of the questions you should be asking yourself when planning a portfolio.
At the very least, you should know the risk you’re willing to take, the growth you’d like to see, and the amount of time you want to invest for. Plan these things before you invest, and you’ll thank me later.
Mistake 2: Not diversifying
“Don’t put all your eggs in one basket”
In nearly every investment scenario, diversity is key. It is essential to have a portfolio that includes investments of different risk levels, types, and sectors so that if things don’t turn out the way you planned (which they rarely do), it won’t affect your entire portfolio.
In practice, you can build up a diverse portfolio in many ways. Here are a few metrics for making diverse investments:
- Risk diversity
- After planning out how risky of an investment strategy you want to pursue, you should allocate a certain percentage of your portfolio to low risk, medium risk, and high-risk investments.
- Low-risk investments are things like bonds, certificates of deposit, and very large, stable companies that sell essential goods, like energy (Consolidated Edison is one such company).
- Type diversity
- Investing in different types of things like real estate, stocks, commodities, indexes, bonds, and more is a good way of ensuring that if one type drops in value others will retain or even increase in value.
- Sector diversity
- When investing in stocks, try to diversify the sectors of the companies. Invest in companies involved in manufacturing, financial services, healthcare, technology, or others. Each of our Industry Reports covers a different sector, so look there for more ideas!
- Company diversity
- The size of the companies you invest in also matters. Try to have at least some small cap, mid cap, and large cap companies in your portfolio.
Mistake 3: Thinking in the short term
Often times, people fall into the trap of getting caught up in short-term losses or gains. Buying or selling a stock because of these short-term price movements almost guarantees poor performance in the long run.
The most successful investors, like Warren Buffet, essentially ignore the short term when making investment decisions. Instead, they buy stock in companies that they believe will increase in value over time, and then they hold onto that stock for decades.
Mistake 4: Buying high, selling low
Buying as prices rise is still buying high, selling as prices drop is still selling low
In theory, everyone knows the well-known saying “buy low, sell high” to be true. The problem is this self-evident truth of investing is much harder to follow in practice.
What usually happens is a prospective investor will see a stock that has been increasing in price, and take this to mean that the company is performing well currently and that it will continue to perform well into the future. However, all an increase in price really means is that people (whether wrong or right) are willing to pay more for stock in that company.
On the other hand, people may see a decrease in stock price and take this to mean that the company is performing poorly, or will perform poorly in the future. Again, this is not always the case. All it really means is that people are willing to sell the stock for less.
You should always pay attention to the underlying reasons that a stock price is moving. Just considering the stock price itself is not sufficient. Before buying or selling, evaluate how the company is currently doing, and how you expect it to do in the future.
Evaluating a company is a completely new ball game, and it brings me to the next investing mistake on the list
Mistake 5: Making things too complicated (or too simple)
A lot can go into deciding whether or not to invest in a company, and it should – it’s a big decision. That being said, it’s important to be careful of over or under-analyzing a stock.
Looking at the fundamentals and performance of companies is very important, and it should be done. But spending too much time pouring over pages of information on different companies can be very time consuming, and you should be wary of getting sucked into all of the information that is available to you.
It is arguably even more dangerous to invest in a company without looking at any of its fundamentals. Jumping into an investment without knowing enough about it is a bad idea in any situation.
As you can probably tell from my lack of a clear instruction, this is not a black and white issue, and there is a middle ground to be had. Finding that middle ground is something that you’ll have to do on your own because it varies for everyone.
In essence, consider everything you can about a company, but try not to get bogged down in all the details.
Mistake 6: Paying too much (or too little) attention to the news.
Turn on your TV, radio, or computer, and you’ll be hard-pressed to avoid some kind of financial news.
News of all types make up a huge industry, and the way this industry makes money is by generating excitement about things every single day.
Some news is very important – events relating to leadership or controversies involving one of your investments could greatly affect your portfolio, and you should consider such news carefully.
That being said, some news is just noise, and you shouldn’t make big decisions about your portfolio based on minor political or global events.
Again, we find ourselves with a middle ground. My advice to you is this: pay attention to what matters, and ignore what does not. This is easier said than done, but I assure you, it will come with experience.
So those are what I believe to be some of the biggest mistakes people make when investing, and the ways I think you can avoid them. This list is in no way exhaustive – there are countless mistakes to be made, but I hope it gives you a head start on avoiding some of the more major pitfalls (like losing $200).
As I inevitably make more mistakes as an investor, I will continue to warn you about everything I can. Investing well is a lifelong process, and the learning never stops!
See you next week,