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Did you know that most investors set themselves up to fail before they even make 1 trade? Failure to do the right prep work, or to have the right mindset can get you eaten alive in the market. And you will most definitely end up like this, losing a lot of dollars and a lot of coins. In this post I will tell you 7 mistakes new investors make and how to avoid them.
Mistake #1
The first deadly mistake that I see a lot of newbie investors make is having outstanding credit card debt, because not only do you owe a certain amount of money to a person, business or institution 90% of the time, but you are also paying a very high interest rate to burrow this money or to have this line of credit. So you are already in the hole, trying to invest money and make money somewhere else when you’re still in the hole, it’s just not a good financial strategy considering the average stock market return is 7% and the average credit card interest is 15%. Even if you have the average rate of return on your portfolio you are still down 8%. Do not kid yourself thinking you are going to do extremely well in the stock market. You may or you may not. But don’t count on it. If you want to become richer or wealthier quicker, then you should pay off the credit card debt, get rid of the interest and now you have the money that you would have paying off the interest back in your pocket. So that is your first step. You need to have NOT CREDIT CARD DEBT because it just doesn’t make any sense.
Mistake #2
The second mistake that I see a lot of newbie investors make is having NO emergency fund. You absolutely need an emergency fund before you start any type of investing. At a very minimum you need 3 months to cover all necessary expenses such as mortgage, rent, utilities, food, gas for your car, you should have 3 months minimum. I would say if you have kids, you should try to have at least 6 months. You need to have some type of emergency fund and why is that? Because savings is very different from investments. And I hear people say all the time that their investment account will also serve as their emergency fund. That is a very bad idea because there is a distinct difference between saving and investing. The purpose of saving is short term and safe. So this should be in a savings account, a money market account, and sure enough it makes no money for you, the interest rate is so low for these accounts, is so miniscule you won’t even notice. But the PRO’s with these accounts is that they are very safe. So the FDIC is going to guarantee that your money is going to be safe and sound, is going to be there, if the roof leaks, you have a medical emergency, something happens with your kid, your car breaks down, you can dig right into your account and that money will be available to you. So you should always have that savings. The difference between savings and investing is that investments should be thaught as long term and also subject to risk.
And I’m not just talking about stock market, any time you make an investment, whether Is the stock market, real estate, a business, investments have risks. It is not guarantee if the business goes wrong, if a real estate deal goes wrong, if you lose money in stock market, you just lost it, so it’s also subject to risk. You have to keep that in mind. So the reason why, you are urge to invest, after you have a sufficient amount of savings is because with investments it should be something that you contribute to and it grows over time. So the time horizon should be years, that you do not have to touch this fund because you will have a lot of volatility, and volatility in the stock market means that you can expect the prices to go up and down, if fact they go up and down on a daily basis. So for your stock price to increase in value it will take time. Actually the bare minimum for me is probably 18 months, and that’s the bare minimum. But usually I’m looking at something that I can hold at least 3-5 years, I know some people hold for 10 years and beyond. So I’t s gonna be up to you, but this is something that you have to grow. So you’re going to look at this as something you should not touch for years, you’re going to be contributing to the account but you should not take out of the account. So keep in mind that an investment account is not a savings account, it should not be used for any emergencies, that’s what savings if for, and you will know that you are not going to have to sale some investment and sale it a bad price, when you should have just had a savings account to take care of these emergencies. So if you don’t have an emergency fund, get that started at a sufficient level before you look at investing.
Mistake #3
The third mistakes is having no long term view. You hear these stories about people trading in and out and making lots of money. That’s day trading, as they’re referred to depending on the timeline which you hold the stocks. Some traders are in and out within a day or within a couple of days. This is not what we’re trying to do here. We’re not trying to trade, we are trying to invest. Over time you’re going to contribute a little bit more and a little bit more so your contribution + the stock appreciation + the reinvestments and it’s gonna start to get bigger and bigger, and you’re gonna get that nice snowball effect. And that’s what you really try to achieve. So when you start this investment you want to say: "Ok this is hopefully where it’s gonna be 5 years from now, or 10 years from now". You cannot look at something, a portfolio or investment and say “Ok, I want to be rich quick in a YEAR.” It’s not gonna happen like that. So the solution is of course to have a long term perspective. It’s not gonna grow overnight. And here is the other thing. You have a little bit of a tax incentive. You know the tax code is always changing, but basically right now it reads like this: If you hold a stock more than a year, you get a special rate on the stock. Which is a lower rate, its called A Capital Gains Tax. As opposed if you buy stock and you hold it less than a year and cash out, then you are taxed at the short term capital gains tax. But what I wanna emphasize here is that you really need to be patient, look out into the distance. Don’t look at it as somewhere where you are going in and out because you are going to miss those times when the stock market is going up and then you will really want to kick yourself, because you will miss on all these precious gains. So unless there is a reason for selling the stock, and sometimes there are reasons where you really need to get out of the stock, just hold on to it, be patient and be disciplined.
Mistake #4
The forth mistake is buying on that hot stock tip. Think about it. You will not buy a home, you will not buy a car, or anything major with your hard earned money and not investigate it further. But for some reason, people do this all the time with stocks. And so, this is a fatal mistake a lot of newbie investors make because once again they’re thinking they will get rich quick, and so they think “this is gonna be the way I’m gonna be able to retire early” or whatever they plan on doing. And this is what I will advise you not to do. Now you can get ideas from other people, but do not make a major purchasing decision based on it. So the solution is, no matter how wonderful it sound, and no matter how much money somebody said they made, you need to perform due diligence at all times. That means, know what you’re buying and why you’re buying. And you got to research it really well. It’s amazing to me, a lot of times I hear people say they bought a particular stock and they have no idea what this company really does, who’s on the management team, what the finances look like, is this stock too expensive, what is the history of the stock, what are the analyst ratings, they know nothing about it, and this things are very important because you really need to know the actual business. For example if you know it’s a energy stock, you need to know the energy stock, you need to know the pro’s and cons of being in the energy sector. If it’s a technology stock, you need to know the pro’s and con’s of being in the technology sector. Because from sector through sector they have certain things that work FOR and AGAINST them, it’s just like right now, a lot of energy stocks are under pressure. Technology stocks we know that what might be HOT today may not be HOT tomorrow. So you need to keep up with the actual business. You also need to know is tis business mostly domestic or international? Because sometimes political events or international events can affect a business here if they do a lot of business abroad. So these are the things you need to know, and also need to dig in to what we call certain metrics which falls under a category called fundamental analysis. But you actually need to look at certain metrics, look at certain ratios to determine the financial help of the business and of the stock. And you should never buy a stock without doing that.
Mistake #5
The fifth mistake is having no exit plan. You always hear people talk about stocks and when to buy, but you also have to have an exit or contingency plan before you make that first purchase for that stock. You have to know how much you are willing to lose whether on a portfolio basis or stock basis before you cut and run, and yes I do advocate buying and holding for a significant period of time, but you have to look at your portfolio and look at the performance of your individual stocks, and determine if this is really worth hanging on to.
And you have to give yourself very strict rules while you’re not emotional, while you’re money is not high up in the stock. And this is why I say, come up with an exit plan before you buy the actual stock. So if you’re rule is that you can’t lose more than 1% of your portfolio and individual stock, when that stock drops to that point, you need to go ahead and sell your position. And once that rules has been violated then you need to go ahead and clear your position. Do not get emotional about stocks, do not convince yourself that is it going to come back because that is one of the worst things that you can do. To convince yourself to violate a rule that you set ahead of time. Rules are there, so you can be very disciplined on your investing. Because if you’re not disciplined, that is a good way to lose money out of your portfolio instead of increasing your profit.
So what you need to do is have a risk management plan, establish your floor before making any trades. Also you if you make a tremendous amount of profit in a short period of time, you need to come up with a rule when you’re going to take some or all that profit off the table. So you have to say: If it’s going up 25%, if it’s going up50 %, if it’s double then how much of that profit am I going to take off the table? A lot of times too, people will look at their portfolio, have a very hot stock and say “I’m rich, I don’t take any profit off the table”. Keep in mind, until you take the profit off the table, that profit only exists on paper, it’s not a real profit. So consider taking some if not all of the profit off the table.
Mistake #6
The sixth mistake is putting all your eggs in one basket. Under no circumstances should you invest all your money in one stock. Let me repeat that again. Under no circumstances should you invest all your money in one stock.
Do not confuse this with a fund where you have a bunch, or a basket of stocks within the fund. That is something totally different. But you should not invest in one individual stock. I don’t care how great the business is, I don’t care how great the stock performance is. What it’s up today, can be down tomorrow, what it’s hot today, can be cold tomorrow. You never wanna do that. Trust me.
The Solution is to diversify. You wanna diversify the sector, and what I mean by sector is by industry, technology, financials, materials, etc. By size, whether is a smaller company or a larger company. And also by business, is it all domestic, or do they also do business internationally. You wanna make sure that you spread it out so you’re not overexposed.
Mistake #7
The seventh mistake is trying to get rich too quick. I know you hear a lot of stories about people getting rich investing in stocks. Well, that usually doesn’t happen for the retail investor. So what you need to do is make sure that you have the correct mindset. This is a way for you to accumulate wealth over time. This is not a way for you to get rich quick. So make sure that you go in knowing this is your objective.
So your solution is to set realistic expectation because the average stock market return is 7%, you may make a little less, you may make more, but don’t count on more than that. So you’re not gonna get rich over night. If you have the correct mindset then you’re not going to make risky decisions. A lot of time people will actually trade to much or buy a risky stock, or a put on positions that they have no business putting on and end up losing a considerable amount of money. If you can have a right mindset and know it’s gonna take time, you need patience and disciplined, you are going to make money on the market. So be patient.
Thank you for reading and I hope this post will help you make better decisions and become profitable in the stock market.