If you have an eye toward increasing your net worth, you’re most likely an investor. Sure, you may not be the next Warren Buffet, but you understand that putting at least some money into the stock market— coupled, of course, with the purchase of a less risky retirement income product — just makes good sense if you plan to get ahead in the financial game. However, many investors tend to “play the markets” as if it were, in fact, nothing but a game. Unfortunately, these are the investors who tend to lose big, making mistakes that could easily be avoided.
Good investors are most often thoughtful investors, and as with everything else in life, the more thought you put into a decision, the smarter that decision are likely to be. The importance of smart investment behavior and decision-making is underscored in one particularly interesting segment of a Money Magazine special report entitled “101+ ways to build wealth.” The report features the collective advice of stock market experts, professionals and magazine readers alike on how you can avoid many of the mistakes that can ultimately sink an investor’s dreams.
So exactly what type of bad behaviors (and ultimately, mistakes) should you avoid when investing?
As identified in a recent Barclays Wealth report, the four most common mistakes investors make are:
1. “Focusing on single investments rather than the big picture.”
2. “Concentrating on a short-term time horizon.”
3. “Taking more risks when comfortable and less risk when not.”
4. “Taking actions in hopes of gaining control.”
Money interpreted the consequences of these mistakes, all of which can deliver a devastating blow to your investment goals. If you focus only on single investments, you run the risk of inadequate asset diversification; failure to concentrate on the long term often results in “mistiming the market”; if you assume more risk when you’re comfortable than you do when you’re feeling less comfortable, you’re far more apt to buy high and sell low; and investors who tend to act in an attempt to gain control often trade far too frequently, incurring the numerous high fees associated with this type of churning.
Avoid Jumping in and out of the Markets
If you’re prone to buying and selling on a whim or upon hearing news of some hot stock, you’re missing out on more than you’re gaining. Market gains most often occur in brief surges, so by the time you catch wind of something, the stock will have already lost most of its momentum. To underscore the importance of staying in the market for the long term, consider this example set forth by Money Magazine:
Assume you started in 1996 by investing $10,000 in an S&P 500 index fund. Based on Allianz returns data, if you kept that money in the market, you would have accrued $22,170 by the end of 2011. If, however, you constantly put money in and pulled money out, you’re likely to have missed the best trading days and the consequences of this behavior can be dire. For example, if you missed the 10 best trading days, your initial investment would be worth a mere $11,040. Worse still, if you missed the 30 best trading days, your original investment would be worth just $4,550 — a significant loss.
Don’t Be a Lemming
As with most anything in life, thinking for yourself is crucial to performing well in the markets. I can still hear my mother’s voice warning, “If everyone you knew jumped off a bridge, would you jump too?” Well, the same principle applies to the markets — just because you notice a mass exodus doesn’t mean you need to join in the panic.
If you’re approaching retirement, most experts agree that a balanced portfolio of 50 percent stocks and 50 percent bonds is best, especially for more conservative investors. This is based on the fact that since 1926, the 20-year rolling average of a 50/50 stock and bond portfolio has delivered 8.7 percent in annualized returns. If, however, you elected to follow the herd of nervous investors who, over the past year alone, pulled a collective $170 billion out of stocks in favor of bonds, your annualized returns would be just 5.5 percent.
Steer Clear of the Hot Pick of the Moment
Remember, you’re in the market for long-term gains, so don’t treat it like a pick-and-win lottery. Whenever the equity markets stumble, a hot new alternative often pops up, attracting news coverage and thousands of investors. The most recent “flavor of the month” was gold. In August of 2011 when the markets were wobbling under the threat of the European debt crisis, many Americans began selling off stock in favor of the precious metal. Indeed, a contemporary Gallup poll showed that an astonishing
34 percent of Americans believed gold was the best long-term investment, while only 17 percent said the same of stocks. But keep this in mind: It took less than a year for gold to lose its luster. Since August of last year, the price of gold has plummeted 10 percent, while the S&P 500 has gained 10 percent.
Paying Down the Mortgage First Isn’t Always Best
If you’ve got credit card debt, go ahead and use your market gains to pay them off. But while the itch to apply that same strategy to the mortgage is all-too natural, Money maintains that with today’s low interest-rate environment and the tax deductibility of your payments, there might be a wiser way to use your extra earnings.
Consider this example: If you had a 30-year, $100,000 mortgage at 5 percent interest and you put an extra $100 a month toward paying down the loan, it would take 21 years to pay off the mortgage. Conversely, if you were to invest that same $100 a month, earning a 7 percent annual rate of return, after 21 years you’d have $57,000. That’s more than enough to pay off the remainder of the mortgage, and you’d still have plenty of remaining funds.
Take Your Stock Tips Well Salted
One Money reader shared this bit of advice, and you’d do well to follow his suggestion. “Following the latest stock tip is a sure way to avoid the steady gains a diversified portfolio offers,” writes David Thompson of League City, Texas. “A tip from an acquaintance is just interesting conversation.”
Nobody has a crystal ball, but with your investment strategy of, diversifying globally and periodically rebalancing, you won’t really need one. If you can avoid making these investment mistakes and keep your market behavior in check, you’ll do far better in the long run. And isn’t that the goal, after all?