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Invest With Confidence by Avoiding These 5 Pitfalls

By Diane Mtetwa - Jan 18, 2021 at 7:31AM

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Knowing what the easily avoidable errors are can save you time and money.

One of the biggest fears you may have about investing is making a mistake. What happens if you buy the wrong stock or enter the market just before a correction? These fears may be so great that they prevent you from doing anything at all. 

This type of inaction means that your money isn't growing as much as it could be, which makes meeting your financial goals more difficult. While never making a mistake is impossible, you can limit the damage by avoiding these five errors. 

A person using a laptop with bar graphs and pie charts while taking notes.

Image source: Getty Images.

1. Not having a plan

If you're going on a road trip, you usually map out the best route to your destination to avoid getting lost.

The same thing is true for investing. Sure, you can just start putting money into different stocks and mutual funds, but with no clear direction on where you want to end up, you may find yourself lost and unmotivated.

Creating a plan for your accounts will help you figure out your best route for meeting your goals. You should outline a purpose for your money: What will you eventually be using it for, and when? This will help you set your risk tolerances and choose an asset allocation model that works best for you.

2. Buying investments you don't understand

Warren Buffett once said, "Never invest in a business that you cannot understand." You don't have to be an expert in everything that you invest in, but you should have a general understanding of how each of your holdings works.

When considering different sectors to buy into, you should have a grasp of the key inputs and trends in those industries. How does each one operate in different market cycles, and what are the risks associated with it?

When buying individual stocks, you can learn about a company's valuation by looking at important measures like its price-to-earnings ratio. You can also research its product lines and determine how it makes money and whether or not you can expect its business to continue growing. 

3. Making emotional buy and sell decisions

When you're losing money, you can easily lose sight of your long-term goals as you nervously watch your account balances decline in value. If you end up too unnerved, you may even decide to sell out of your investments and abandon the market entirely.

The opposite feeling comes into play when you're making money. Excited that you're getting wealthier, you might end up buying investments without evaluating them properly first. This can lead to paying more for them than they're worth. 

Your buy or sell decisions should leave out emotions as much as possible and instead take into account how well your potential investments will help you meet your goals. How well do they match up with your time horizon and your appetite for risk? Positions that you hold should be chosen with these objectives in mind and only sold if they no longer match them.

4. Trying to time a market bottom or top

In an ideal world, you'll time your transactions perfectly: You'll sell just before a crash when the market is at a high, and buy back in at the very bottom of a pullback.

But unless you have a crystal ball, this will only happen when you get lucky -- and rarely, if at all. Making this mistake can mean that you're spending precious days out of the market, which can cost you a lot of money. 

If you invested $10,000 into the S&P 500 on Jan. 3, 2000 and left it there until Dec. 31, 2019, you would have ended up with $32,421. If you missed the 10 best market days during those 20 years, you would only have $16,180 -- half as much. Rather than trying to time the market, your best bet is buying your investments with the intention of holding them long term. 

5. Putting all of your eggs in one basket

Jumping on the bandwagon when an investment is doing really well can be tempting. For much of the early years of this century, real estate investments were top performers. But the Great Recession took its toll on that sector in 2007 and 2008. If you were only invested in real estate at the time, you would've lost a substantial portion of your wealth. 

Diversification involves spreading your risk out among various investments and industries, and it can help limit your losses. If during that same time period, you had a diversified portfolio made up of, say, large-cap stocks, U.S. bonds, and real estate, you would've only seen one-third of the losses of a real estate-focused portfolio, according to the Callan Institute.

When you invest, there are some mistakes that you can't help making. But some can be completely avoided, and doing so will save you money and time. The more you can bypass them (as well as learn from the mistakes you do make), the more confident you will be as an investor. 

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