- As a financial planner, I've witnessed plenty of big investment mistakes.
- Trying to time the market, holding concentrated stock positions, and taking on too much risk are a few.
- One of the biggest? Not investing at all. Make a plan – and then get started.
- Read more stories on Personal Finance Insider.
In my opinion as a financial planner, you need to invest if you want to grow wealth. Participating in financial markets is a great way to get your money working for you so you can increase your assets over time.
But this path is littered with potential pitfalls that you need to avoid if you want to have a positive outcome in the long run. And for most people, it's more important to avoid big mistakes than it is to consistently hit home runs.
To help you do just that, here are four mistakes to watch out for with your own investments – and a handful of simple strategies to keep you on the right course over time.
1. Trying to time the market
It's tempting to think that you can avoid recessions and market downturns, because these events look so obvious in hindsight. The problem is, that's the only time when the path is crystal clear: once it's behind you.
In the spring of 2020, my company had a few clients reach out to say they wanted to move all of their investments to cash. The coronavirus was spreading across the globe, and watching the market lose 30% so quickly felt scary.
Because we work with people in their 30s and 40s, our investment strategies account for very long time horizons. Thankfully, all of those clients listened to our advice to stay the course – and were extremely grateful they did by the end of the summer that year, when the market was hitting new highs once again.
It's easy to think you would have known better with the help of hindsight. In the present moment, though, things are much murkier and more uncertain. Trying to guess what the market will do next leaves you susceptible to emotional decision-making, rather than rational planning.
If your focus is on growing wealth over many decades, then worrying about what the market is doing day to day is a distraction. We expect ups and downs along the way, but as long as you stay consistent – and stay in the market, rather than jumping in and out – you'll be much better positioned for success.
You can get lucky with market timing once or twice, but it's a poor strategy for long-term success. Instead of relying on chance, set a strategic course for your investments – and stick with it over time.
2. Thinking irrationally about risk
Most people understand basic concepts around investing and risk. They know that investments come with risk of loss, and that the higher the potential reward the more risk that's required.
But for some reason, most people are very bad at applying these concepts to their own circumstances.
People overestimate their own skill while downplaying the role of randomness in outcomes; they know unfortunate events happen but tend to think about bad things happening to other people, not themselves.
This can lead to some really big investing mistakes, like:
- Making speculative bets in the market, rather than maintaining a diversified portfolio with an appropriate allocation for both their risk tolerance and ability to afford risk
- Attributing positive outcomes entirely to skill, and bad outcomes entirely to bad luck – which can pull down the quality of future investment decisions
- Ignoring risk entirely when evaluating an investment that is emotionally appealing
It's hard to maintain a completely rational, objective perspective about our own money. It's good to get an outside perspective, at least from time to time, which is where professional advice can be hugely valuable.
3. Maintaining highly concentrated portfolio positions
The other day, my firm spoke with a prospective client who shared they had a $3 million total net worth – and $1 million of that was held in company stock they owned through an equity compensation package.
Given that 33% of their net worth is dependent on the stock price of a single company, they are taking on a lot of unnecessary risk. Should anything happen to that company (or if they lost their job with that business), their net worth could plummet, they could lose the ability to fund their goals, and their entire financial future could be in jeopardy.
All investments come with risk, but a diversified portfolio helps mitigate the risks that you face. It also helps reduce overall volatility in your portfolio (and portfolios with lower volatility tend to perform better over the long term).
Concentration risk, on the other hand, unnecessarily does the opposite to your portfolio: it increases the investment risks you face and introduces higher volatility.
Our general rule of thumb is to limit exposure to any single stock position to no more than 5% of liquid net worth. There are exceptions, of course, but this is a good starting guideline to use when considering whether to sell or hold a position.
4. Avoiding investments altogether
There's no shortage of investment mistakes you can make. But perhaps the biggest is a bit counterintuitive: not investing at all.
I usually see this take one of two forms:
- Someone always finds reasons to wait to start investing: they'll get started when they have more in savings, when they make more money, when something about the market changes, etc.
- Someone builds a great savings habit and amasses a lot of cash, but leaves it all in the bank because they are afraid of taking any investment risk at all.
In the first case, this is a huge mistake because the biggest advantage you can give yourself when it comes to growing wealth is the amount of time you give your money to earn compounding returns.
Warren Buffett isn't insanely wealthy because he's an investing genius (although he certainly is good at it). It's because his money has compounded for over 70 years, thanks to the fact that he started so young.
Don't make excuses to start investing. Do it now, and refine and improve your approach as you go.
In the second case, the mistake here is failing to understand that having cash sitting around not earning anything is also a risk. People feel lulled into a false sense of security when they have a lot of cash when they fail to understand that money is losing purchasing power over time thanks to inflation.
Yes, liquidity is important, but if you don't need that money for many years, growth is also critical. Have a strategic way to determine how much cash you truly need on hand – then consider investing the rest.
Simple strategies to improve your odds of success
These aren't the only mistakes you can make with your investments, but they are some of the most common and widespread that I see in my work as a financial planner. If you want to avoid these yourself, you can keep the following basic strategies in mind:
- Choose a strategic investment plan and stick with it
- Invest for the long term and avoid high-risk approaches like day trading, speculating, or market timing
- Know both your tolerance for risk and your capacity to take risks. Then, think as objectively as you can about risk (and know that bad things can happen to anyone, even you!), even if that means bringing in an objective, outside party to help you make decisions
- Maintain a globally-diversified portfolio to reduce risk and volatility
And of course, just get started. There's no such thing as a perfect investment strategy, or the perfect portfolio. Some mistakes along the way may be inevitable, but the most important thing is getting in the market and staying there as long as you can.
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