Guilty of any of these? Stop now
Investing can seem challenging to the uninitiated. A lot can and does go wrong. Entire books have been written on the topic of investment failures. (And I could add to that library. . .)
But assuming you’re not already rich from a family trust, you’ll need to save for your key goals, such as your kid’s college fund or your retirement. And you’ll need to beat inflation. By a lot.
And the earliest you start the better. Interest on your money compounds; in other words, you get interest on your interest. Over the long-term, that adds up. By a lot.
So, start today, even if it’s only a few hundred dollars.
Below, are the biggest pitfalls to avoid.
Does your employer offer you a Defined Contribution retirement plan that you contribute to, via payroll deductions? A 401K plan is the most common, but you may also have a Thrift Savings Plan (for government employees), or a SIMPLE plan. If so, your employer may be required to “match” any contributions you make up to a certain amount, usually around 3% of your salary.
(Once you’re vested) this is a risk-free 100% return on the money you contribute for the match. You don’t even have to “invest” this money in anything other than the designated money market account if you don’t want to.
(Although you should go with a relatively aggressive investment if you’re decades away from retirement.)
However, if you ignore your match, you are simply saying no to FREE MONEY.
“Stock tips” are always a dangerous temptation. Today, with social media, we’re inundated with them. Every day there is yet another “success story” about someone who bought the perfect stock or followed the perfect investment strategy. We all suffer from FOMO or fear of missing out.
Just remind yourself, that the other guy has different goals than you. And most definitely, a different risk tolerance. And they probably have conveniently failed to mention all their failures up to this point.
Know what you’re buying and know its risks. If everyone is talking about something, odds are the big moves are already over.
Ironically, one indicator that many market prognosticators use is a measurement of investor sentiment. When investors get “greedy” the market usually tanks soon after.
Being in the market always incurs risk. Just because something has been going up in the past doesn’t mean it will continue to do so.
We take steps to mitigate this risk. One way is through diversification. Instead of putting all your bets on one horse to win, spread the love around, and instead purchase a mutual fund or exchange-traded fund (ETF) holding hundreds of stocks.
To further mitigate the risk, split, or “allocate”, your portfolio into different areas. Stock and bonds, high cap (“capitalization”) and low/medium cap, or US and international.
Your portfolio doesn’t need to be complicated. One stock index fund, one bond fund, and a money market fund for excess cash, are all that is needed.
But at the end of the day, if the entire market is down, then everything may be down. (Except the money market fund.)
If your goal is long-term, many decades from now, a market slump is simply a small bump in the road. In the long-term, the market always bounces back. Eventually.
But how do you react to these “bumps” in the road? During the past two bear markets, in 2000 and again in 2008, the S&P500 lost almost 50%!
How do you feel when you look at the balance of your life savings and it is now HALF of what it used to be?
- This is bad, but I’m sticking to my plan. I know it will work out
- This is bad, it makes me uncomfortable. Deep breaths. Deep breaths.
- This is bad, I’m losing sleep now.
- Panic! Panic! Panic!
If you answered either 3 or 4, you are taking on too much risk. There is no shame in this.
Everyone is different and everyone is at a different place in their lives. If you’re closer in age to retirement and have a family to support, you are probably more risk-averse than the singleton with many decades to go.
If you’re losing sleep or worse, you may need to reduce your percentage of stock and/or invest in more conservative value-oriented stock. Hold more bonds or even cash equivalents such as money market funds.
You should be “aggressive” enough to achieve your goals in the allotted time, but no more.
Beware though, during a good market everyone develops amnesia and we all go in too strong. (See FOMO above.)
But what if you find yourself victim to this market amnesia and FOMO, and the worst happens? The market tanks and you panic.
The worst thing you can do at this point is panic sell at the bottom. Because once the market hits bottom, it bounces back up. Fast.
Some of the strongest rallies (up) occur during a bear market. Some of these rallies lead to the market recovering. Alternatively, sometimes the market quickly pivots down and goes even lower than before.
Did I mention that no one — and I mean no one — can accurately predict a market bottom?
Because you never know if “this time” is the bottom, you don’t know when to get back in.
In a previous post, I compared market timing to buy and hold. Spoiler alert: there was little advantage to market timing.
Try not to let emotions get to you. The best way to do this is to make a plan. This plan also includes “rules” for you to follow.
Your plan starts with your financial goals. For each “bucket” of investing money you have, what is its purpose? For each purpose, what is the timeframe?
Short-term goals, such as a down-payment on a house should be invested conservatively or not at all. However, if your timeframe is multiple decades, such as retirement, you can afford to invest more aggressively.
Once you’ve determined your goals, what asset allocation, or percentage of stocks to bonds, will get you to your goal in the allotted time without any more risk than necessary?
If you’re under the age of thirty (and arguably under forty) almost all your retirement money should be in the stock market. You have decades to recover from market downturns.
If you’re a bit older (or closer to retirement), you may tweak this percentage based on risk tolerance and the ability to make your goal.
Next what stock funds or bond funds do you choose? If you prefer index funds or have limited choices as part of your 401K, then this step will be quick.
Otherwise, look for low management fees, good performance compared to peers, and up and down variability (risk). Note that funds with a better return may accomplish this by taking on higher risk, which is shown by the standard deviation.
If ESG investing (Environment, Social, Governance) is important to you, include that in your criteria. Morningstar includes a “globe” rating of funds that invest in companies that follow ESG principles.
Are you invested exclusively in mutual funds or exchange-traded funds (ETFs), or do you own individual stock or individual bonds? If the latter, at what point do you sell it?
Most of us should not be market-timers, but instead, buy and hold our chosen funds and/ ETFs.
But unlike the market in general, individual stocks, bonds (and even very niche mutual funds) may not necessarily recover from a downturn. The latter will require a “stop”, pre-determined in advance, of when you plan to sell.
This is your plan. Did you stick with it, or did you change it up several times during the year? Worst yet, did you fail to follow one of your “rules”?
Changing too often creates two problems. One, you may be incurring more commissions and fees than necessary. But second, and more importantly, you are most likely selling low and buying high, from a poor-performing fund (or allocation or strategy), to a strong-performing fund (or allocation or strategy). However, the strong-performing fund may be near the end of its strong run, and then you repeat the process. . . Do this a few times in one year and you kill your return.
There is nothing inherently wrong with switching from a poor-performing fund to a strong-performing fund. However, this should be done during an annual, or bi-annual review.
During this review, you may check several things about your plan. Does your planned percentage of stock vs bonds still match your financial goals and risk tolerance? If not, perhaps a new allocation should be considered.
Does your current allocation match your planned allocation?
If the market has been good to you, your stock percentage will be high, and if the market has been poor your bond percentage will be high. Rebalance your portfolio by selling the excess and using the proceeds to buy more of the under-represented asset. (Depending on your financial institution, they may do this automatically for you.)
Are your chosen funds still the best choice in terms of performance, investment goals, risk, and management fees?
Those are the five biggest mistakes. Remember, always take your 401K match and don’t follow the herd, unless it aligns with your own plan. Know and respect your risk tolerance, so that you don’t find yourself in a situation where your emotions take over and you do something stupid, like panic and sell at the bottom. Try to avoid all these mistakes by having a plan and sticking to it. Good luck.
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This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Links are included for reference but should not be considered an implied endorsement of these organizations or their products. Please seek out a licensed professional for current advice specific to your situation.