Millions of Americans have sat on the sidelines during the four-year bull market, nervously wondering if they should put their money at risk, and thereby having missed out on some colossal gains. Yet beginning investors are always afraid of making costly mistakes, and unfortunately, that only leads to more procrastination -- and more missed opportunities.
The best way to avoid common investing mistakes is to get fair warning about them before you make them. With the goal of giving beginning investors knowledge they can use to steer clear of potential pitfalls, here are 12 mistakes that beginning investors often make.
1. Paying too much in expenses to invest hurts your results right out of the starting gate. Instead of choosing funds with up-front sales loads and hefty annual expenses, aim your fund investments toward no-load funds with lower fees. Over your lifetime, the savings can add up to hundreds of thousands of dollars.
2. Owning multiple funds doesn't mean you have a safely diversified portfolio. Often, different funds own the same underlying investments, leaving you doubly exposed if bad news hits.
3. Chasing performance will almost always leave you on the back end of a trend right as it reverses. Longtime investors in SPDR Gold (NYSEMKT:GLD) and iShares Silver (NYSEMKT:SLV), for instance, earned huge profits over the past decade. But those who climbed on the precious-metals bandwagon in 2011 have seen huge losses. Being late to the game isn't always fatal, but you should never expect the same returns in the future as an investment's past results.
4. Making knee-jerk stock purchases and sales immediately after important news leaves you vulnerable to professional investors, who step in during such periods to take advantage of emotionally driven beginning investors. Waiting until the dust settles will often get you better results.
5. A great company isn't always a great investment. Hot companies often have their stocks bid into the stratosphere, at which point they've lost most of their chances to produce big returns. Sometimes, you have to concede that you've missed out on most of the potential gains a stock can produce and look for other opportunities.
6. Investments with high dividend yields don't always produce good total returns. Often, high yields signal danger, as the recent experience of Annaly Capital (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC) show. Rising interest rates have crushed those stocks, costing investors the equivalent of two years' worth of dividend payments just since the end of April. For funds, distribution yields are often meaningless, as they can include a portion of your own invested capital being returned to you.
7. Making frequent trades will cost you in several ways. Not only do you incur greater transaction costs, but any gains you earn on investments held for a year or less are taxed at higher short-term capital gains rates that can be more than double longer-term rates.
8. Not using tax-favored retirement accounts also provides a big drag on your overall returns. Roth IRAs can give you tax-free growth that can save you from having to pay taxes of more than 40% on your investment income for certain taxpayers, while even traditional retirement accounts let you defer taxes on income and capital gains within the account until you make withdrawals.
9. Failing to make enough contributions to your 401(k) plan at work to max out any employer match is simply giving up free money. Sometimes, you have to be careful to weed out bad investment options in your 401(k), but usually, you can find a good enough choice to justify grabbing the matching contribution.
10. Taking money out of an old job's 401(k) rather than rolling it over to a new 401(k) or IRA account will not only cost you a substantial amount in taxes and a 10% penalty in most circumstances but also leave you with that much less in retirement savings down the road. Moreover, the opportunity cost of not investing that money is even greater.
11. Watching financial television will generally just whipsaw your opinions in both directions, leaving you more confused than you were when you started. You're better off getting news and insight from sources that are less concerned about short-term trends and that instead will give you a better sense of long-term prospects.
12. Waiting too long to start investing takes away the biggest asset you have as a beginning investor: time. Markets rise and fall over shorter periods, but in the long run, picking investments that will steadily climb in value produces the wealth that will help you reach all your financial goals.
Get started today!
The financial markets are a scary place for beginning investors to get started with their investing. But with so much of your financial future at stake, you owe it to yourself to face the challenge. Avoiding these mistakes should give you more confidence that you can invest successfully.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.