Editor’s note: This article was first published in August 2010. The 3.5% loan rate in its example reflects 2010 conditions.
In the first part of the most common mistakes investors make in the stock market, we looked at the mistakes beginners make. Today we cover the most serious mistakes, the ones that can lead you to ruin. Before reading this article, it’s a good idea to read the others first. You can find them here:
Now let’s go over, in short, what you should never do when investing, especially in the stock market. The first big mistake is taking out a loan or credit and using that money for your investments.
1. Taking out a loan or credit
Even experienced investors and smart people fall into this one. Their reasoning: if they borrow from the bank at 3.5% interest and invest the money in a stock they consider safe, then as soon as the stock returns 8%, they’ll have made a 4.5% profit.
The reasoning isn’t actually bad. In fact, great investors have used it and made large sums of money this way. But it has also caused many investors’ personal ruin, because without meaning to, it pushes you toward the short term, and in the stock market the short term doesn’t always go the way we want.
Bear in mind that if you invest borrowed money and the investment doesn’t turn out as you expected, not only will you make no profit, you’ll still owe the money to the bank. At that point, an investor feels like any compulsive gambler feeding money into bingo and slot machines: as a rule, he tries to solve his current problem by borrowing more and hoping for a stroke of luck.
This serious investment mistake is the reason for the myth that a person can go bankrupt investing in the stock market, when in reality, as we’ve discussed before, if you let a stock mature, its value generally tends to stabilize in the long run.
2. Lack of patience
We all want money as fast and as easily as possible, but as we’ve also discussed, fast, easy money doesn’t exist.
Lack of patience usually goes hand in hand with mistake number 3: we’re impatient because we’re investing money we can’t really spare and are counting on.
3. Investing money that isn’t meant for investing
Before putting money into a fixed-term deposit or the stock market, you absolutely need to have drawn up a financial plan. In any personal or investment plan, the first thing you learn is to separate your personal money from the money you’ll use to generate more money (the capital set aside for investing).
When we invest that capital, we have to make sure we can cover our bills and loan repayments without touching the money we have invested. Otherwise, we’ll always be in a hurry to make quick profits instead of focusing on the real return on our investments.
If we invest thinking only that we need a return within 3 months to meet our personal payments, all that can happen is that things don’t go as we hoped, we’re forced to sell our shares at the worst possible moment, and we simply end up deeper in debt.
If you look closely, these three serious investing mistakes have something in common: every one of them focuses us on the short term, and the short term sometimes works out well and sometimes goes really badly.
Remember: before investing, you need to know the investment product inside out and have both an entry strategy and an exit strategy. We know the conditions under which we go in, but we can’t know for sure how we’ll get out, or how long it will take to get out with a profit.
Further reading
Featured image: Pierre André Leclercq, CC BY 4.0, via Wikimedia Commons.
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