If you've been considering investing, you know it's a scary world to get into. How do you know what's right and what's wrong when so much of it adds up to luck? Well thankfully, our partner site DailyWorth has figured out a few of the most commonly made mistakes, and they're willing to share:
Investing in the stock market is always a gamble and it doesn't hurt to have a little luck on your side. But the difference between a successful investor and an unsuccessful one can be as simple as doing a few things right and avoiding certain mistakes. Steer clear of these eight common missteps and you can greatly improve your chances of achieving your investing goals, whether you're a novice or semi-pro:
Read on to find out what made the list.
- Not starting early enough. Yes, better late than never. But with investing, the earlier the better. As many of us in the industry like to say, "It's not about timing the market, it's about time in the market." The longer your money is invested, the more opportunity there will be for your growth to compound and your ups to far outweigh your downs. If you invest $10,000 for 40 years, assuming an average rate of return of 8% and no additional contributions, you'll have approximately $200,000 more than if you'd invested for 20 years.
- Not saving enough. Unless you have lottery-winning kind of luck, you most likely will not be able to rely on stock or fund picking alone to succeed. Not only should you start investing as early as possible, you should also contribute as much as possible to your investments. If you have $10,000 invested and add $500 per month versus $250 per month for 40 years, assuming that 8% return, you will have close to $1 million more saved! The harsh reality is that most of us need to be investing 10-20 percent of our annual income in order to reach our long-term savings goals.
- Being overly aggressive. The stock market is hot right now, hitting new all-time highs in the past few weeks and prompting investors to pour money in. The same was true in 2007 and 1999. But what followed the year after those years was frightening and, in many cases, devastating. Taking advantage of a market rally is great, but be prepared for the inevitable downturn too. A varied and more balanced portfolio that includes less risky investments too can help protect you when stocks head south. Keep in mind that even mutual funds, which are inherently diversified to an extent, can be heavily concentrated in certain asset classes and therefore too aggressive for your risk tolerance. So make sure you know what you have and are comfortable with the risk potential.
- Chasing performance. There is a good reason why the financial services industry constantly preaches: "Past performance is no guarantee of future results." Still, many people select investments solely based on recent returns. The danger is that if you invest in a hot fund or stock, you may jump in just in time for the freeze. Did you know that emerging market stocks was the top performing asset class in 1999 and 2007 and the worst performing class in 2000 and 2008? By having investments in a variety of asset classes you will better be able to share in the growth when certain classes do well while avoiding serious losses when some don't.
- Timing the market. Remember I said that it's about time in the market, not timing the market. Studies have shown that, for most of us, trying to jump in and jump out of investments at the "right" time leads to more bad results than good. Also, the costs of frequent trading can significantly reduce returns, especially in taxable accounts. Assuming your investments are diversified and reasonably priced, you should hold onto them as long as possible and avoid knee-jerk reactions. Additionally, you will almost always be better off investing sooner than later.
- Overpaying in fees. Many mutual funds have a one-time sales charge of up to 5.75% (a.k.a. "load") and an annual expense ratio of 1.5 to 2+ percent if they are actively-managed, not to mention a potential "wrap fee" of 1 to 2 percent you might be paying a professional to manage your portfolio for you. While a few percentage points may not seem like a lot to pay at first, over the long run it can take a serious toll on your growth. Check out the SEC's mutual fund cost calculator to see for yourself. And recent studies have shown that the majority of actively-managed, higher cost funds do not outperform their respective indexes. Bottom line: Managing your own portfolio and choosing no-load, passively managed index funds or exchange-traded funds whenever possible will help minimize cost and maximize your savings.
- Underestimating inflation and taxes. Over time, everything gets more expensive. That is inflation — one of the few certainties in life, along with death and taxes — and it has averaged 3 percent over the past century. A million dollars may seem like a lot now, but in 30 years it will be worth much less thanks to inflation. At the current rate of inflation, you'll need to save more than $2 million dollars to have then what feels like $1 million today. Combine that reality with income and capital gains taxes, and you will probably need to save a whole lot more for retirement than you might think. You should also maximize savings in tax-deferred and tax-advantaged accounts like 401(k)s, IRAs, and Roth IRAs, in which you can delay or avoid paying taxes on growth and future withdrawals.
- Not rebalancing. Different asset classes grow at different rates and some grow much faster than others over a given time frame. For example, if you started out this year with a balanced portfolio of half stocks and half bonds, the surge in stocks over the past few months has likely caused you to have a larger percentage of your portfolio in stocks and a smaller percentage in bonds if you haven't rebalanced yet. Depending on your risk tolerance, your portfolio might be too out of whack and uncomfortably aggressive. By rebalancing at least once a year, you can sell positions that have gotten too large and reinvest the proceeds in other positions that might help reduce risk (or increase it in some cases) and capitalize on opportunities in your portfolio. An easy way to help ensure appropriate rebalancing is to invest in target-date or "lifecycle" funds that rebalance automatically based on time horizon. Just keep in mind that these are actively-managed funds and typically more expensive than index funds or ETFs. Also, just because a fund's target date might align with your savings goal time frame, it doesn't necessarily mean that it aligns with your risk tolerance. So make sure to pick one with an asset allocation that you are comfortable with.
Bottom Line: save as much as you can as soon as you can, avoid high fees and taxes, diversify your investments, rebalance periodically and stay invested as long as possible. Follow these rules and your success as an investor will be much more of a sure thing.
— Jocelyn Black Hodes
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