Editor’s note: This article was first published in October 2012. The Abengoa example, with shares soaring around its capital increase, refers to autumn 2012 and is unsourced. Abengoa later went through a major restructuring.
We have all made, are making and will make mistakes when investing. What’s more, even knowing the most common kinds of mistake, we fall into them again, perhaps because we think this time is different or that this occasion might be an exception. Perhaps the reason we fall into them despite knowing better is that we can’t learn the lesson until we’ve suffered it ourselves.
Here are 10 of the most common mistakes people make when investing. Take note.
1. Being blinded by high returns.
This mistake applies both to the stock market and to other kinds of investments people sometimes ask me about. We should follow a basic principle: the higher the return, the higher the risk. So when you come across an investment that offers a 50% return with 0% risk, believe me, even without knowing the product, the risk will be 100% and the return will probably be 0%.
In stock market investing we hear about high dividends, and sometimes paying a high dividend doesn’t mean the risk is lower or that the investment will end up with a positive return. We will talk about dividends shortly.
2. Impatience.
Being patient is a great virtue in every part of life. In investing, impatience usually costs money. You need patience both to wait for the right moment to get into an investment (a stock) and to assess whether you should stay in it.
A few examples. Sometimes, especially when we’re starting out, we want to invest in a stock and we want it NOW!, even though it’s in a downtrend or its price is already too inflated. In both situations, more than one of us has seen the stock start costing us money five minutes after buying it, because we didn’t wait a few days, weeks or months for it to finish a correction or find support (a floor). Once a stock is losing us money day after day, that’s when we should stop being patient and cut the loss quickly.
In other cases, we buy into company X at €10, six months later it’s worth €15 and we decide to sell. A year later we find those shares trading above €30, and we bitterly regret not holding on, not least because it was a very low-volatility stock that deep down we knew had potential.
3. Trying to jump on a moving train.
If you try to jump on a moving train, there’s a good chance you’ll take a nasty fall. We open our trading platform and see company X up 30%. We go to the news section and see that the company has announced a major contract that will boost its results. Could it rise 50% or 150%? I could buy in case it keeps rising tomorrow. You could, but it could also happen that the shares go from being up 30% to closing up just 15%, so you would lose 15%.
We can learn a lot from moving trains, such as why we didn’t hear the news in question in time to be among the first to buy the stock. Some people take note of this mistake and put the means in place so that next time they don’t miss relevant news about a company. Others jump on the moving train.
The most recent example is Abengoa’s shares. During Abengoa’s capital increase, the shares shot up by as much as 60%. Some people bought shares above €4.50. A few days later, the shares were already trading below €3. I’m sure anyone who tried to catch that moving train has learned the lesson.
5. Following the crowd.
In investing you have to be careful with bubbles, and with fashionable companies. We need to work out whether these companies are too cyclical and whether the cycle could be a bubble about to burst. Recent cases are the dot-coms and, more recently still, the real estate and financial bubble, although in that last case, simply investing in the stock market at inflated peak levels already meant investing in a bubble.
6. Uncomfortable investments.
If, once you’ve invested, you lose sleep and can’t stop worrying about your money, your fears are probably justified: you haven’t made a good investment.
7. Expectations that are too high for minimal effort, or too low.
What is a reasonable average annual return for an investor? As we explained in that article, the average annual return (if you’re lucky) is said to be 8%. I don’t agree, but expecting a 30% annual return by investing at random and without following prices is too much (although you might get lucky).
On the other hand, investing in the stock market looking for just 8% a year would not, in my view, make up for the risk. We will also cover this point soon.
8. Investing small amounts to avoid risk.
Sometimes we do everything perfectly. We choose a rising market and a rising stock, we buy at the ideal moment and the share price climbs 40%. Too bad we only invested €500, because that high return will barely be noticeable. We were afraid of losing money even though there were “green” signals in the stock and the market, and even our instinct told us we were doing the right thing.
Sometimes, don’t avoid risk: accept that it’s there and face it, as long as you trust that instinct. Only those who take risks achieve their goals.
9. Investing before paying off toxic debt.
By toxic debt we mainly mean credit card debt, whose interest sometimes exceeds 20%. In other words, if we manage a 15% return, which is excellent, but we’re paying 20% interest on a loan, we’re still losing money. First we save and pay off that kind of debt, then we invest.
10. Confusing long-term investing with neglect.
Some investors are so loyal to the long term that they don’t bother following the news affecting the company, news that could send the share price plunging. “I’m a long-term investor; if they lose 30%, they’ll recover it in a few years.”
That’s a respectable way of thinking, but why take a temporary 30% loss when you can see it coming, when you could get out of the stock and buy it back 30% cheaper, and then benefit from the rise afterwards?
Remember that if a share is worth €1 and falls to €0.50, the loss is 50%, but if we buy it at €0.50 and it rises to €1, the gain is 100%. So not only do you temporarily lose 50%, you also miss out on a 100% gain.
I know people who still hold the shares they bought in 2007, some of which have now lost as much as 90% of their value. Didn’t they see the signs after losing 20%?
On the stock market, when we sell shares, we can sell them because someone else is buying them. On that basis, we can see how many investors aren’t paying attention to the markets, because sometimes I buy shares after an announcement that will make them rise 5%, 10% or even more. Someone sells them to me. (They don’t want to make another 10%.)
At other times, I get rid of shares because they could plunge 30% or even more, and someone buys them from me. (They’re willing to lose 30%.)
To avoid these situations, investors who don’t have much time to follow the markets only need to set up an email alert with keywords for the company. In this simple way they can at least find out in time about events that could make their company’s share price collapse.
And those are 10 of the most common mistakes… so common that I’ve personally made some of them, after more than 10 years of warning others about them.
Further reading
- More investing mistakes and tips from the experts
- When is the most profitable time to invest? Stock market curiosities
Featured image: Jan Brueghel the Younger, Public domain, via Wikimedia Commons.
