Putting your money at work in the stock market can help your savings grow significantly. But you can also lose money when you invest.
And conflicting stories of investment successes and failures that you may have heard could have you caught between feeling excited and scared about your new venture. While you may still make mistakes as you learn along the way, you can limit them as much as possible by avoiding these four things.
1. Not having a plan
Investing should start off with having a plan because it can make attaining a goal that you've set more likely, like saving for retirement or growing your accounts to $1 million. Your plan will consider things like your time horizon, how much you will invest and how often, and the investment vehicles that you will use.
Will you invest in passive securities like ETFs and mutual funds, or will you pick individual stocks? What will your asset allocation model be, and what type of rate of return can you achieve? Figuring out this type of information in advance can help you map out a plan for meeting your goal. If you are further away than you want, make tweaks that will get you on track.
2. Chasing returns
As a new investor, finding your next purchase by looking at what has done well in the past may be tempting. But predicting which asset class will do best from year to year is impossible. And if you invest based on what did best the year before, you may constantly find yourself buying your investments at their highest price. For example, emerging markets went from being the best-performing asset class in 2017 with a 37% gain to the worst performer in 2018 with a 15% loss. An investment in real estate did the same thing in 2006 with a 42% gain followed by a 7% loss in 2007.
The more you do this over time, the more it could lead to inferior returns. Instead, owning a diversified portfolio will help you avoid this guessing game. And while you won't always be able to boast about buying the top asset class of the year, mistakenly buying too much of the worst performer won't be your downfall.
3. Trying to time the market
If you invest a lump sum just before a bear market, you could lose a lot of money before making any. If you put $100,000 into large-cap stocks at the beginning of 2008, you would've seen your account balance drop by 37% to $63,000 by the end of the year. And you wouldn't have gotten back to your original investment until amount until four years later in 2012.
If you can sell out of your investments before a stock market correction, you can avoid losing money. But if the losses you anticipate never happen, you could miss out on a growth opportunity. For example, if you sold out of your large-cap stocks at the beginning of the COVID-19 pandemic thinking that the year would finish out negative, you would've been wrong and missed out on 18% growth for the year.
The chance that you'll invest at the wrong time can be nerve-wracking, and employing a strategy like dollar-cost averaging can help you avoid this mistake. When you do this, you put a certain portion of money into investments that you've picked over pre-set times. Because the stock market varies from day to day, so will the prices at which you make your purchases -- some will be higher while others will be lower. But the main benefits of this type of process are that it will help you get invested, and it could reduce the anxiety you feel about buying your holdings at exactly the wrong time.
4. Being impatient
Stocks can grow more than investments like bonds but this is over time -- and the performance that you experience can fluctuate each year. If you bought shares of the S&P 500 in years like 2015 and 2018, as a new investor, you may have been unimpressed by the returns that you earned. In 2015, this index earned 1%, and in 2018 it lost 4%. You could've even sold out of this investment as a result; having a lack of long-term perspective can cost you big.
If you held on to shares in this index over a 30-year period, you would've earned an average rate of return of 9.8%, and if you had $10,000, your account could've grown to more than $165,000. While there will be times you buy a stock that you don't end up keeping for a long time, most of the purchases you make should have a long-term objective.
Investing your money is a great way you can build wealth. But making avoidable mistakes can lead to lackluster returns, which could make meeting your goals harder. Having a plan, focusing on time in the market, diversification, and being patient can make this process simpler.