Investing

The 5 biggest mistakes investors make and how to avoid them

Letting emotion guide your investing strategy in the short term can have negative long-term effects.

Twenty/20

If the influx of chaotic headlines in the runup to the upcoming presidential election has you spooked, you're not alone. Investors generally have been jumpy, given widespread uncertainty over a litany of factors affecting the economy, including the Covid-19 pandemic and the fading possibility of a second economic stimulus package getting through Congress. Wednesday marked the worst day for stocks in months: The S&P 500 shed 3.5%.

But in times of market turmoil, remember what your mother used to say: If all of your friends were jumping off a bridge, would you do it too? Just because investors have reason to be fearful doesn't mean that you should let emotions derail your strategy.

"Sticking to the plan requires discipline," says Kelly Mould, senior vice president of the wealth team at advisory firm Johnson Financial Group. "It's counterintuitive to how we're wired." When investors lose touch with their plan and invest emotionally, they can make mistakes that damage their long-term results, she says.

Read on for five of the most common errors investors make, and how you can avoid them on your way to robust, long-term returns.

Not starting early

If you haven't begun investing yet, you may be tempted to let things quiet down, or focus your attention on other financial matters, before you start building a portfolio. But the longer you wait, the more you squander your two most valuable tools as an investor: time and compounding interest.

Consider the following: A 21-year-old intern contributes 10% of his $40,000 salary to his 401(k) plan annually. His employer contributes a 3% match, and his portfolio earns an annualized 8%. Assuming his salary increases by just 2% per year, by the time he retires at age 67, his 401(k) would be worth about $2.2 million. If he waited until he was 30 to start, his account would be worth just over $1 million. If he waited until 35: $690,000.

"If you're offered a 401(k), under all circumstances you should take advantage," says Mould. "Even if you're thinking, 'I should be taking care of this student debt first' you can still manage it, and it is going to make things possible for you that without it will never happen."

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Panic-selling

When the market swoons, you may be tempted to take your chips off the table to avoid further losses. But in doing so, you're likely missing out on potential gains.

While the 3.5% decline from earlier this week may have spooked you, it can help to remember that history shows markets tend to bounce back pretty quickly even from their dreariest days. From 1945 through 2019, stocks in the S&P 500 rose by an average of 14% in the 12 months following a daily decline of 3% or more, according to data from BMO Capital Markets.

One way to keep yourself from selling your stocks in a panic: Make sure your portfolio aligns with your tolerance for risk by holding a proper mix of stocks and more conservative investments, such as bonds. Your brokerage likely has a questionnaire that can help you determine how much risk you're willing to take on, Mould says, adding, "If you can't stomach, say, a 20% percent loss, you should add a defensive sleeve to your portfolio that will help mitigate losses."

Trying to time the market

Maybe you're not panic-selling. Maybe you're just selling now and waiting for the market to drop so you can buy back in at a lower price. That's not a smart idea either, experts say.

"Timing the market is very difficult," says Kevin Smith, a certified financial planner and vice president of Wealthspire Advisors. "You need to be right twice — when you get out and when you get back in."

And if down days in the market have you sitting on the sidelines, waiting to get back in the game, you may be missing out on important gains. From the beginning of the bull market through 2019, some 40% of the market's five best days occurred within a week of one of the five worst days, according to BMO.

Missing out on the best days is a big deal for your long-term returns. Over the 15 years ending in December 2019, the S&P 500 returned an annualized 9%. But investors who missed the best 10 days over that span would have earned an annualized return of just 4%, according to data from Putnam Investments. Leave out the best 20 days, and the return falls to just over 1%.

Putting all your eggs in one basket

Young investors may be tempted to pile their money into a few investments or a few types of investments. But having a broadly diversified portfolio guarantees that some of your investments will stay afloat when others sink, and vice versa. "Ideally, some part of your portfolio should always be doing well," Smith says.

This means that stock investors shouldn't focus solely on large-company U.S. names but also allocate resources to small and midsize companies, as well as overseas firms in developed and emerging markets. Depending on your stomach for volatility, you may even want to shift assets into more conservative vehicles, such as bonds.

Ideally, some part of your portfolio should always be doing well.
Kevin Smith
Vice President, Wealthspire Advisors

For a good visual of how different types of assets behave, check out financial consultancy Callan's Periodic Table of Investment Returns. In any given year, different types of investments take the lead while others falter. Having a mix smooths your portfolio's returns over time.

Slow-and-steady returns can add up over the long run. From December 1999 through March 2020, a hypothetical portfolio constructed by Charles Schwab consisting of 60% stocks and 40% bonds outperformed an all-stock portfolio. The secret: losing less during drawdowns. The blended portfolio surrendered far less than its all-stock counterpart during the Tech Wreck and the Great Recession. Remember, an investment loss of 50% requires a 100% gain to break even.

Over long stretches, investors can win more by losing less.

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Why you shouldn't panic when markets are bumpy

Video by Stephen Parkhurst

Forgetting to buy low and sell high

"Buy low, sell high" is the oldest mantra in investing, but it's easier said than done, right? Well, if you're trying to time a particular investment, yeah. But making adjustments to your portfolio on a regular basis can ensure that you're buying shares when they're relatively cheap and selling them when they're relatively expensive.

Setting your portfolio to rebalance at regular intervals (an option at most brokerages and workplace retirement plans) ensures that you regularly sell shares in your investments that have gone up while bolstering your allocation to those that have struggled, says Karen Wallace, a certified financial planner and director of investor education at Morningstar. And rather than looking at market drawdowns as times to sell, "look at it as an opportunity to pick up more shares at a cheaper price."

Another way to guarantee that you're paying a good price for your investments is to try a practice known as dollar-cost averaging. By investing the same amount at regular intervals (say, a set portion of each paycheck) you guarantee that you buy more shares when prices are low and fewer when they're high, driving down the average price you pay per share over time. "If you're dollar-cost averaging and the market goes down, you're buying the same stocks you were buying three months ago," Wallace says. "They're just cheaper."

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