20 Worst Mistakes Rookie Investors Make
Stock market investing for beginners can be exciting — or terrifying. After all, you want your money to grow so you can reach your investment goals. But investing in stocks can be a tricky thing, especially if you follow daily investment news or have friends telling you about investing in penny stocks.
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Manage your money more effectively by avoiding these common mistakes that rookie investors make.
Last updated: May 6, 2021
1. Investing Without a Plan
Just because investing is easier and less expensive than ever doesn’t mean you should just dive into without having a plan. Not only are there literally thousands of different types of investments available, they can have wildly different risk-reward profiles. Without knowing what your investment objectives are, it can be hard if not impossible to pick the right investments to get you there.
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2. Buying Recently Hot Stocks
The current hot trend in investing is to buy whatever stocks are being touted on message boards like Reddit. The poster child for this investment “strategy” in 2021 was Gamestop, which shot up over 400% in a single week and ultimately traded as high as $483 per share, up from its 52-week low of $3.77. However, that stock currently sits at about $158 per share, marking a 67% loss for those who bought just a few months ago. While certainly exciting, this is not an investment method that you’d want to rely on to fund your retirement, as it essentially amounts to gambling.
Instead of chasing hot stocks, do your own research on how to invest your money.
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3. Buying Only One Stock
The key to investing is diversification. By diversifying your investments, you can better navigate the highs and lows of the market. If you invest in only one stock, for example, you could lose your whole nest egg. While diversification won’t insulate you from losing money, according to Fidelity, diversification is a way to maximize your returns for a given amount of risk.
4. Not Knowing What You’re Investing In
The legendary investor Warren Buffett is well-known for his aversion to investing in companies he doesn’t understand, most notably tech stocks. Although this personal policy meant Buffett missed out on Microsoft when it was just starting out, it also meant he avoided countless companies that went bankrupt.
As Buffett told CNBC’s Becky Quick in 2020, “Everybody, when they buy a stock, should be able to take a yellow pad” and write down exactly why they plan to invest in that particular company. According to Buffett, you should only invest in companies that you understand and can explain to someone in plain English without resorting to outside resources.
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5. Buying Stocks on a Recommendation
When it comes to stocks, people are never short of recommendations. It could be your rich cousin, your brother-in-law or your rich next-door neighbor, but unless you do the research yourself, you won’t know if it’s right for you. Not only are “friendly tips” notoriously unreliable, but the person making the recommendation likely has no idea what your investment objectives and risk tolerance are.
6. Checking Investments Daily
As tempting as it might be, checking your investments every day is really stock investing for dummies. If you’re a long-term investor, there’s no advantage to keeping an eye on every little movement in your portfolio, as Warren Buffett said in an interview with CNBC.
As Buffet told Becky Quick, “I know what markets are going to do over a long period of time: They’re going to go up. But in terms of what’s going to happen in a day or a week or a month or a year even, I’ve never felt that I knew it and I’ve never felt that was important.”
7. Buying Solely on Brand
Don’t let yourself be dazzled by a fund or company brand. Although Vanguard and Fidelity used to dominate the no-load mutual fund industry, for example, nowadays there are nearly unlimited options when it comes to investment choices, including exchange-traded funds, or ETFs. Even if you’re a Vanguard or Fidelity loyalist, it doesn’t meant that you have to only invest with that fund company. Although both management firms have reliable reputations for long-term performance, they each have their share of clunkers in their stables as well.
This isn’t to pick on either Fidelity or Vanguard, as both companies have plenty of long-term proven winners. The same holds true for any firm or fund company. Always research your investments from any company to make sure that they match your own personal objectives and risk tolerance.
8. Not Having an Emergency Fund
As excited as you might be to learn how to start investing in stocks, make sure you also have an emergency fund that’s separate from your investing money. According to the U.S. Securities and Exchange Commission, investors should have six months’ worth of income in an emergency fund and keep it in a FDIC-insured account such as a savings account or certificate of deposit.
If you invest your emergency fund money in the stock market, a market crash could leave you in the dust when you need that cash most.
9. Over-Investing in Your Company’s Stock
According to Kiplinger, having 10% or more of your portfolio in a single stock is a concentrated position. This can raise red flags due to its excessive risk. There are numerous examples of investors who had most or all of their money in company stock and lost everything, from Enron to WorldCom to Lehman Brothers.
Sometimes, you might not have a choice when you have money invested in your company’s 401(k) plan or ESOP; however, that means you must be especially careful with investments outside your retirement accounts. When your future wages are tied up in the company, along with your financial capital, your present and future wealth can be jeopardized if you lose your job or the company stumbles.
10. Avoiding Limit Orders
With stock market trades being executed faster than ever, you can be putting your money at risk if you use market orders instead of limit orders. With a limit order, you can define the price you are willing to pay for a stock — or the price you are willing to accept, if you are selling — but with a market order, your trade will be executed at the current price, regardless of what it is.
According to CNBC’s Jim Cramer, “With a market order, you never know what price you’re going to get, which is why I always tell you to use limit orders,” Cramer said. “With a limit order, the transaction won’t go through if the price goes beyond the level you’re comfortable with.”
David Stein of Money for the Rest of Us recommended putting in a limit order when buying a stock. A buy limit order sets the maximum price you are willing to pay for a stock.
Stein explained the peril of avoiding them: “Most first-time investors place market orders which are filled at the going ask prices. The problem with market orders is a temporary mismatch between the volume of buy and sell orders [which] can send the price soaring or plummeting, if only for a few seconds,” he said. “This could cause the beginning investor to have their order filled at a price much higher than they would have liked.”
11. Investing Without an Exit Strategy
If you don’t set up a predefined strategy for determining when to sell your investments, you risk putting yourself in a situation where emotion and short-term reasoning can cause you to make unwise decisions.
You can use a range of strategies — including setting a maximum loss or gain that causes you to sell, an amount of time you plan to hold the investment for, or even certain company fundamentals to check to help you decide whether to buy more, hold or sell.
12. Not Researching Funds in Your 401k
A company 401(k) plan is convenient, but not researching the options for where to invest is a poor choice. The 401(k) plan will have a default option, often a lifecycle fund, balanced fund or managed account — but that might not be the preferred option for you. Most 401(k) plans have plenty of information about investment options and performance, so if you do your research, you can match up the right funds with your personal investment strategy.
13. Ignoring Fees
Make sure you know what you’re paying in fees before you invest. For example, the Financial Industry Regulatory Authority, or FINRA, has a website where you can search over 30,000 mutual funds and exchange-traded funds.
A small difference can result in a drastic result over time. If you pay 1% per year in management fees on a $50,000 investment that earns 7% per year over a 30-year term, for example, that’s about $100,000 in fees. If the fee drops just 0.5%, you pay just over $50,000 in fees.
14. Confusing a Bull Market With Brains
Wall Street is full of folksy wisdom and old sayings, and one of the most popular is that you shouldn’t “confuse brains with a bull market.” In other words, don’t make the mistake of thinking you’re a great investor just because you’re picking stocks during a bull market. Just because you happened to invest during a roaring bull market — when stocks are on the rise — doesn’t mean you are a brilliant investor. Instead, view investment results only over the entire market cycle.
15. Being Impatient
Many investors have the far-fetched expectation that an investment like a stock or fund will go up as soon as they buy it. In reality, the long-term average return for the stock market as a whole is just 10%. That means that if you’re expecting an “average” return, your stock will take an entire year to go from $30 to $33.
Of course, that 10% long-term return that’s often quoted for the stock market is merely a long-term average. It’s entirely possible that even if you buy an index fund, you’ll lost money over the short-term.
Think about it this way: If you buy a stock or fund that goes down 10% the first year, goes down 20% the next year and returns 85% in year three, you’ll have just about your 10% per-year average return. Sometimes, you have to be quite patient to earn your returns from your investments, and selling at the wrong time could cause you to miss out on a huge future gain.
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16. Not Vetting Your Investment Advisor
Not all investment advisors are required to have specific qualifications, and they’re not all held to the same standards for giving you advice. Some brokers are only bound by FINRA’s Rule 2111, otherwise known as the suitability standard. This requires that brokers ““have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer…”
This is in contrast to the fiduciary standard, which legally requires advisors to work in your best interest and put your interests ahead of their own rather than merely suggesting “suitable” investments.
17. Trying to Time the Market
Market timing is one of the worst investment moves when investing in stocks for beginners. Most investors who think they can time the markets by buying at the bottom and selling at the top are typically disappointed. A famous study of Brazilian day traders from 2013 to 2015 found that 97% of traders that persisted for more than 300 days lost money.
A 2020 study of Robinhood users found that the most popular stocks purchased on Robinhood showed average 20-day returns of negative 4.7%. A sensible investment approach of dollar-cost averaging in safe financial assets can allow you to participate in a growing market and buy more shares at lower prices.
18. Taking on Too Much Risk
Rookie investors don’t account for risk tolerance when determining how to balance investments across multiple asset types. Your risk tolerance refers to how much risk you can afford and are willing to take with your investments. Part of your risk tolerance comes from your time horizon: If you need the money in two to three years, you shouldn’t take on as much risk as you would if you didn’t need the money for 40 years.
Risk tolerance also includes personality. If you can’t stomach the thought of 20% of your portfolio disappearing in a bad year, you need to factor that into how you choose your investments — even if you don’t need the money for a long time.
19. Taking on Too Little Risk
On the other hand, if you’re saving for retirement that won’t come for 20 or more years, you can take on more risk because you have plenty of time to rebound after a bad year. If you play it too conservatively, such as holding all your money in CDs, inflation could outpace your returns. Although you won’t lose money with CDs, the effects of inflation can eat away at your purchasing power.
20. Holding on to Losing Positions
Many rookie investors hold on to losing stocks and sell stocks that increased in value, hoping to recoup their losses when the losing stocks rebound and lock in their gains before the improving stocks fall. This fallacy is known as the disposition effect.
Be aware of the strengths and weaknesses of the companies you’re investing in so that you make smart holding, buying and selling decisions.
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Barbara Friedberg contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: 20 Worst Mistakes Rookie Investors Make
