Beginner Investment Mistakes to Avoid

Investing can be intimidating for people who aren’t well-versed in stocks, bonds, mutual funds, and indexes. Those are just a few of the many investment options that are available and understanding them can be challenging. While it’s easy and normal to make mistakes along the way, you can minimize mistakes by doing research and coming up with a strategy during the early stages of your investing journey. For those who decide to take the leap and begin their investing journey, here are a few mistakes to avoid.

Not Having a Clear Strategy

In an eagerness to begin investing, it’s easy to jump straight into buying securities with no clear strategy. While starting on the investing journey is always better than not investing at all, it’s also important to understand what you’re investing in and why. Having a clear investing strategy is critical because it helps factor in important elements like how much you’re hoping to invest, for what purpose, and for how long. Knowing this information beforehand may improve your chances of success.

Knowing your risk tolerance and time horizon is part of a clear strategy. Your risk tolerance is a simple understanding of how much risk you are comfortable taking with your investments. Another key consideration is your time horizon or how long you plan to invest. Not being aware of these factors could lead to your investments not working for you the way you envisioned. For instance, if you have a low tolerance for risk but you build a portfolio that is aggressive, it could lead to anxiety and dissatisfaction due to the volatility of the investments. Conversely, if you have a high tolerance for risk but end up investing too conservatively, it can lead to dissatisfaction if lower-than-expected returns are achieved. Understanding these aspects of your investment strategy goes a long way to determining what investments can make the most sense for you.

This is critical because not every investment makes sense for everyone! There is no ‘one size fits all’ approach to investing. People who are looking to generate monthly income will have a very different strategy from an investor who is looking to invest for retirement in forty years. Before you pour money into any random investment, it is imperative that you take the time to consider your investment strategy. If necessary, consider talking with an investment professional to formulate this.

Investing in the Wrong Vehicles

New investors may not be familiar with the many investing accounts out there and how each has different financial implications. For example, they may begin their investing journey by placing all of their money in a 401(k) and hoping to withdraw funds for a financial goal like buying a new car in five years. However, a 401(k) may not be the right vehicle for this goal, considering early distributions may result in a 10% IRS penalty and the need to pay income tax on the amounts withdrawn. It may, instead, be more ideal to place money into a traditional brokerage account since there are no penalties for early withdrawal. Another alternative could be putting the money into a certificate of deposit, high-yield savings account, or bond.

Lack of Diversification

Diversification is critical when investing, but new investors may not know this. As a result, they may invest too heavily in a single type of security and make themselves vulnerable to concentration risk. A diverse portfolio can help balance losses that happen during market downturns with gains that may be achieved from other market sectors so investors potentially keep more of their money working for them over the long-term.

For example, a new investor may focus on buying stocks only from their favorite tech companies like Apple and Google. While they may see upward movement in their portfolio when tech companies are doing well, when those companies are underperforming, that investors’ entire portfolio will, too. Had the investor included other securities that are potentially more resilient during market downturns in their portfolio, their account may not have taken such a hit.

A diversified portfolio typically has a range of asset classes, including cash, stock, bonds, real estate, and foreign assets. It’s also important to rebalance your portfolio regularly to ensure it continues to aligns with your investment goals. If you’re unsure how to create a diverse portfolio, it may be worthwhile to meet with a finance professional like a portfolio manager or financial advisor to help with this.

Lack of Tax Planning

Beginning investors may quickly become excited about earnings but not realize there are also tax implications. Most earnings are subject to income or capital gains tax. Without careful planning, a chunk of earnings could go to Uncle Sam.

There are multiple tax strategies investors can use to minimize taxes, and one is to put investments into tax-advantaged accounts like an IRA, 401(k), or 403(b). Although there are limits around how much can be saved in these accounts and when money can be withdrawn, they can help defer or reduce some of your tax bill.

There are also strategies like offsetting capital gains against capital losses and holding an asset for longer than 12 months before selling it to benefit from long-term capital gains tax rates. Long term capital gains are typically taxed at a lower rate than short-term capital gains (profit you make from selling assets held under 12 months).

Remember that investing isn’t a journey you have to do alone. Using the help of qualified finance professionals such as financial advisors and certified public accountants can make the journey easier.

Chasing the Herd

Sometimes beginner investors follow the herd. They follow an investment strategy simply because it is what everyone else does. They buy into the market when they believe the market is good and then sell out of their investments when the market is down. However, disciplined investors understand that staying disciplined in a down market position allows you to participate in any recovery, which is the most important time of the market cycle to be invested.

While it is easy to follow the herd, it is essential that you stay disciplined. Don’t allow undisciplined investors to influence you to abandon your investment strategy, even in the most difficult of markets. Disciplined investors will even invest more in the market while it is down rather than sell out. This is because they understand that the key is time IN the market, and not TIMING the market.