Top 5 mistakes new investors make
Investing is a great way to build wealth and save for your retirement, but there are some common mistakes first-time investors tend to make. If you're just starting out, here are five of the biggest pitfalls to avoid.
- Not putting aside money for emergencies
Investment markets are volatile, there's no getting around it. Never invest money that you think you will need access to in the next five years and make sure you have some cash put aside for emergencies. Without this cushion, you're more likely to be forced to take on costly debt if you run into trouble, such as the loss of your job.
A good rule of thumb is to have at least 6 months' worth of living expenses in a high-interest online savings account. What's more, before you start investing, make sure you pay off any high-interest debts, such as credit cards and personal loans. The money you save on interest payments is likely to exceed the income you would generate through investing.
- Not setting financial goals
As the saying goes, ‘that which is measured, improves'. It's important to set yourself a budget, monitor your investments and lay out some achievable goals of where you want to be in 10 years.
Don't try to wing it. Identifying goals and measuring your progress makes it easier to focus on what steps are needed to get you where you want to be. If you haven’t tried out the goal calculators found on the InvestSMART homepage I highly recommend you do.
These cover off the major goals most investors have like retirement, saving for a house and setting aside savings for children’s education. Not only will they calculate the return you need and how much you will need to save but also help with selecting the right risk profile to align to the timeframe of the goal.
- Buying risky stocks and not diversifying
Betting the farm on a single stock is a really good way to end up without a farm. Owning a broad portfolio of asset classes, such as property, Australian stocks, international stocks, cash and fixed interest, is less risky and more likely to produce satisfactory, consistent returns over time.
If you're just starting out with a small amount of capital, it can be tempting to put it all in one or two exciting growth stocks you’ve heard about from friends or in the press, but you may be better off investing this initial nest egg in a diversified portfolio. It may not be as exciting as picking those one or two stocks, but it will provide you with a more consistent return. And just as those exciting stocks can increase tenfold, they can also go to zero, giving you a horrible introduction to investing and putting you off for life to the detriment of your future wealth.
- Buying or selling based on current headlines
The business news is specifically designed to excite investors and keep you reading, but if you're jumping on or off the bandwagon at the same time as everyone else, you're more likely to be buying when markets are high or to be selling when they are low.
It's natural for people to favour activity over inaction when they see exciting headlines, but unnecessary trading also bites into your returns due to brokerage fees. Research by the University of California found that those who traded the most lagged the overall market's performance by 6.5%.
If you're investing for the next 10 or 20 years, what happened in the markets today probably doesn't matter. What does matter is your diversification and the alignment of it to your investment goals. You can control what investments you hold but you cannot control the movements of the markets. A lot can happen in that time, so ask yourself whether today's conditions – good or bad – are likely to be temporary.
- Panicking when your portfolio goes down
Seeing your portfolio drop 30% or more can feel horrible. But don't make the mistake many made in 2009 by selling into the fear and then missing out on the market's recovery. Keep calm, focus on the long term, and remember Warren Buffett's timeless advice: ‘Be fearful when others are greedy, and greedy when others are fearful.'
If your heart starts to race when you see your portfolio down by 10% – and, believe me, at one point it will be – remind yourself that the stock market will always bounce around in the short term. That volatility is a source of opportunity if you stick to adding more funds to your portfolio when it is down.
If you have a long-term outlook one of the best times to add to your investments is when everyone is panicking.