Investing in stocks, done well over a reasonable period of time, can be an incredible way for you to build wealth. The problem, though, is that it can get incredibly tempting to make some stupid moves that might seem like good ideas at the time you make them, but will likely cause you more harm than good.
Experience can be a harsh teacher, especially when it comes to your money. Make big mistakes, and they can cost you years of compounding and make it far tougher for you to reach your life goals. When it comes to investing, nobody is perfect. Still, there are a handful of completely avoidable stupid moves you should avoid if you want to improve your chances of winding up with that potential wealth from your investments. Here are four of them:
Can you avoid these?
No. 1: Attempting to magnify your returns through portfolio leverage. Borrowing to invest is a tough proposition in the best of circumstances. Borrowing against the value of your investment portfolio in order to try and juice your returns via leverage can be downright financially suicidal.
The issue is volatility. Even if you are ultimately right about a given stock, the market may very well disagree with you in the short to mid-term. If your portfolio is leveraged when the market moves against you, you may become subject to something called a "margin call" and be forced to exit your position. In the end, it doesn't matter if you're ultimately proven correct if you can't participate in your expected returns because you were forced out of your position by a margin call from being leveraged.
No. 2: Trying to capture short-term moves via a churn-heavy trading strategy. Every trade you make costs you money via commissions, SEC fees, and losses due to friction from bid/ask spreads. On top of that, if by some miracle you happen to be successful with that trading, the taxes can take a substantial chunk from your paper profits. Short-term investing gains are taxed at your marginal income tax rate, and any tax is due for the tax year you take the gain.
On the flip side, consider a long-term investment, which can compound for years or even decades before it gets taxed and which, when it does get taxed, generally receives a favorable capital gains tax rate. Of course, you should never let the tax tail wag the investing dog. Still, once you consider all the churn costs of a frequent trading strategy, it becomes apparent just how tough a hurdle you face from the total costs of that churn.
No. 3: Letting your emotions drive your investing decisions. Because of the billions of dollars trading hands, the market can be an incredibly emotional place. Nobody wants to be the sucker left holding the bag when a stock collapses, and nobody wants to be the sap left behind, missing out for not getting in "in time" to capture the big run.
The problem is that if you let that type of "thinking" drive your investing decisions, you lose sight of what a share of stock really represents -- a part ownership stake in a business. That business has a value based on what it owns and/or what it earns, and over time, that value reflects in its market price.
Buying and selling based on how far the market's emotional roller coaster has mispriced a company's stock vs. its business value is a great idea. Indeed, that's the central tenant of the value investing strategy that made Warren Buffett a multi-billionaire. Becoming part of the emotional frenzy that gives investors like Buffett their opportunities to profit? That's not such a good idea.
No. 4: Forgetting that the market is bigger, faster, and stronger than you are, yet has no memory. The market doesn't remember or care what you paid for a stock, what your sell target is, or even what you think the company behind that stock is really worth. Additionally, the market won't move either up or down just because you want it to do so.
Like a herd of stampeding cattle, the market will do what it will do, and if you try to stand in its way, you might very well find yourself getting run over. And lest you think you can move fast enough to get out of the way of that stampede, remember this: There are well-heeled traders paying enormous amounts of money to shave fractions of a millisecond off the time it takes to connect to and trade in the market. By the time you see a stampede coming, it's probably already too late to do anything about it.
What you can do instead
Still, you can make great money investing in the market, and a great way to do so is to do the opposite of those four stupid moves. While the well-heeled pros fight for speed, you look for the long-term opportunities thrown away in an instant by their short-sighted algorithms.
After the market's emotional roller coaster drops a company's stock far below its true value, you make your investment and buy for a bargain price, then wait for the market to eventually realize its mistake. And when you do look to buy, look for solid companies trading at reasonable prices with the intention of holding.
Sure, either due to a significant shift in the company or because the market offers you a price you can't refuse, you may one day find yourself selling your investment. But as long as you avoid leverage and the risk of margin calls, you can be in charge of determining when and why that happens.
In the end, reasonable investing isn't all that difficult, as long as you avoid those four stupid moves.
Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.