The current market conditions we have been going through over the past few months are unprecedented. If you have money in the stock market you have probably seen the prices of your portfolio going up and down much more than you have seen in the past 🤯. Although, there is no answer to whether the volatility of the markets will continue in the short, medium or long term, now is more relevant than ever to think about some of the most common mistakes people make while investing. If you manage to avoid them, whether in a crisis or not, you will definitely have an edge against the market and possibly even outperform it.
What are the most common mistakes when investing in stocks and how to avoid them? Before answering this question, I would like to clarify this is specifically referred to stocks and not other types of asset classes, although some of the following principles can apply to all different types of asset classes. So let’s get started!
- Not thinking like an owner. You have to always think like an owner when you are investing. The reason this is so important is that it will first shape your mindset and push you to do your research to make sure there is little chance of you losing any money.
- Make sure you understand the business you are putting your money in. If you don’t understand how the company or asset you are investing in works, you are not investing, you are gambling. So before you invest, ask yourself, “do I know how does this business operate?”. If you understand the business, you will also understand what are their strengths and weaknesses and whether it is safe to stay invested or not.
- Price vs value. One of the first things people look at is the price of the stock. That is the price that shows in your broker for a specific share, in this example, you can see the price of Apple stock is at $317.73 USD. Although that is the price you need to pay in order to own 1 share of Apple stock, this does not give you the full picture or tells you the value of the company. In the words of Warren Buffett, “Price is what you pay, value is what you get”. So remember, not because the price of something is high in your eyes, means that is worth that or is valuable or not.
- Thinking short term. This is probably one of the most difficult to master, it certainly took me a long time to learn that the key to success in investing is patience. Whenever you make an investment it is important for you to understand that results won’t happen overnight. Each time I make an investment I make it thinking long term and knowing that in some cases it will take between 3 and 5 years for the price of the stock to reach a return I am happy with (in some cases it never does).
- Listening to the wrong advice. One of the things I recommend everyone is that no matter who is giving you advice on where to invest, it could be your financial adviser, your friends, colleagues or even if you hear it on CNBC or Bloomberg, you need to back it up with your own research. Not saying that if you have a trusted source you should ignore it, but we are all humans after all and make mistakes, so it is important you double-check as opposed to regretting a capital loss later.
- Leverage. Especially if you are just getting started. Although leverage is a great tool if you are making a sound investment in something you are sure it will give you a good return to pay back the borrowed money if you cannot afford to risk both the loaned money and your initial capital do not use leverage.
- Not controlling your emotions. One of the basic principles of investing is to buy low and sell high, and it is much easier said than done. Remember that markets fluctuate and prices change, so stick to your strategy and goals. Only sell your investment if you no longer believe in the fundamental story that made you invest in the first place. Investing in stocks is not for everyone and if you can’t stomach a drop in the price of 30% or more, you should reconsider the types of assets you should invest in. Just take the following image as an example that shows how $10,000 invested in the S&P500 Index for the period of 1999 through 2018 would have performed by staying fully invested (going through the drops of the dot com bubble (2000) and the subprime crisis (2008)) against cashing out and missing the best days of the market. Keep in mind that some of the best days in the market happen just right after the worst days in the market.
- Trying to time the market. This one is simply impossible, by default markets are irrational in the short term, but they tend to be more rational in the long term. Therefore, trying to guess when is the perfect time to invest will only hold you down in potential gains. In order to avoid this mistake, make sure that you the companies you are investing in are close to their fair value, have great growth prospects and a good management team.
- Diversifying too much or too little. Too little diversification could defeat the purpose of diversification at all, and too much diversification could make your selection of stocks irrelevant as the same return could be very similar to that of an index fund. Most people think that diversification (adding more than one stock to your portfolio) will de-risk your investment. This is true but it is also not the full picture, as you add more stocks you need to also consider their correlation. If you invest in 1 stock that on average goes up when the market is down, and you add 1 more stock that does the same, you are not really de-risking, but adding more risk to your portfolio by diversifying. To avoid this mistake try to add different asset classes to your portfolio, focus on the correlation between them and pay more attention to the weighs of each individual stock in your portfolio.
- Waiting for a stock to break even before selling. If you have learned to not be fooled by your emotions and buy, hold or sell your stocks as long as the fundamental story of the company is still good, you probably won’t commit this mistake. However, if you think that waiting for the stock to go up in price until it breaks even so you can sell is a good strategy you will be wasting your time. If the price of a stock drops, it is important that you take a look into the fundamentals of the company before making any decision. Ask yourself, has anything changed in the way the company is managed? Have they lost their competitive advantage? Is the reason you made the investment is no longer there? If you are able to identify why has the stock price dropped and you feel the price will recover eventually as it is just an irrational fluctuation of the market you could even add more money into that position. However, if you identify that the stock is no longer a good investment, do not wait, simply sell it and move on. You will encounter some losses every now and then, so don’t get discouraged by them.
I am grateful I was able to identify some of these mistakes early on when I started investing, it has saved me a lot of time and money but most important sanity and I hope you find some value from it too. Remember, stick to your strategy and risk tolerance and always put in the work and thought behind your investment decisions, nothing worth it is ever fast and easy.
In the coming posts, I will break down the different types of asset classes you can start investing in, how I analyse stocks and what are the basic things you should look for before making an investment, and other finance, investing and money related topics.
This is a project on its very early stages. If you have any topics you would like me to cover, recommendations or if you simply liked the post, please feel free to get in touch with me directly — diego@konfidence.app or @diegogueort on Twitter
I am also running an Instagram page where you can find tips on investing and recommendations to complement this blog — IG @konfidence.app
