Investing can seem daunting when you're just starting out, but growing your wealth this way isn't as difficult as most newbies imagine it to be. That said, there is risk involved, and it is possible to lose money, especially if you make the three common mistakes listed below. Keep them in mind as you continue your investing journey and do your best to avoid them at all costs.
1. Investing in companies you don't understand
Investing in businesses you aren't familiar with can be risky, even if the company is a leader in its industry. When you don't know how a business makes its money, you have more trouble predicting how its decisions will affect its stock's performance. But when you understand how a company works, you can more easily identify red flags that might signal a possible downturn.
Warren Buffett recommends investing in your "circle of competence." This means sticking to the companies you're really familiar with and avoiding areas you aren't as familiar with. Doing this can also save you time because you won't have as many companies to research as you would if you were trying to invest in every industry.
2. Selling emotionally
Ups and downs are a normal part of investing, and so is losing a little money from time to time. When this happens, usually the best thing to do is nothing. The stock market can be volatile in the short term, but it tends to go up over the long term. If you've invested wisely, you'll probably get back what you've lost and then some over time.
But if you sell your investments when they're down, you're locking in that loss. You can invest your money elsewhere and try to make a profit off of something else, but if you're tempted to sell every time a stock dips in value, you're probably not going to do very well.
That said, sometimes it actually does make sense to sell a stock. If it's been doing poorly for several years or its management is making reckless decisions, that might be a sign that it's time to remove the stock from your portfolio. But a bad quarter isn't anything to get too upset about.
If you're worried about making emotional investing decisions, try to limit how often you check your portfolio. Even once or twice per year is probably enough if you're investing for the long term.
3. Trying to time the market
Trying to time the market means attempting to buy when a stock is at its lowest point and sell when it's at its highest so you can earn a handsome profit. It sounds like a great strategy, but it's nearly impossible to know when a stock has reached its highest or lowest price. If you guess wrong, you could end up costing yourself a lot of money, especially if you sink a substantial portion of your savings into a single stock.
A better approach for most people is dollar-cost averaging. This is where you invest a set dollar amount on a schedule. So it could be $50 a week, or $200 every month, or whatever suits you. The point is to stick to a schedule. If you do this, you'll sometimes buy when prices are high and sometimes when they're low. Over time, this averages out, and you end up paying a reasonable price for all your shares.
This eliminates a lot of the guesswork associated with trying to time the market. You probably won't earn as much as you would if you'd timed the market successfully, but you're also less likely to lose a lot of money.
These aren't all the mistakes you can make while investing, but if you can steer clear of these, you should be off to a good start. Just remember, investing is a skill and like any skill, it takes practice to get good at it. Start small and be patient with yourself. As you grow in confidence, you can begin investing larger sums.