Here, I’ll take a look at investing pitfalls that I may have personally succumbed to and should generally be avoided.
Powered with this knowledge, you can avoid these investing pitfalls and help grow your funds.
Investing is never a guarantee
Whether you’re new to investing or have been investing for years, the main thing to realize is that investing is never a 100% guarantee. Sure, the S&P has historically gained 9-10%, but as history can also dictate, those gains can be wiped out in an instant.
It certainly is difficult to see all your hard-earned money invested in stocks get cut in half, and that scares people. It certainly scares me.
The only comfort I have in market corrections is that I’m investing for the future – 10, 20 years down the road. Even though it’s not 100% that the stock market will rise again after a big correction, the long-term time frame allows time for the market to go back up.
Market corrections also allow for shares of good companies to be picked up at discount prices. Buy low, sell high right?
Buy low, sell high?
Conventional wisdom says to buy stocks when they’re low and sell when they’re high. The only issue with this conventional wisdom is, “how do you know when it’s low enough to buy and high enough to sell?”
This investing pitfall involves trying to time the market.
This is super important – you can never always accurately time the market. Sure, you can get lucky and get into the stock market at its lowest point, but you can also get in at its highest point and have nowhere to go but down.
A way to combat trying to time the market is to put investing on autopilot and invest automatically on a standard basis. This is called dollar cost averaging. This averages the entry point of your purchase over time so you may underpay and overpay at times, but will always average out.
You can always set some cash aside to buy extra when the market is down to further lower your entry point when you sell.
Emotions are your enemy
When the market drops 200 points and your portfolio takes a nosedive 5%, what do you do?
What happens if that losing streak continues for several days, or even weeks and your portfolio ends up dropping 20%? 50%?
Any right-minded person would have their stomachs dropped and their emotions running high in fear. The seemingly logical choice would be to sell your positions to limit any additional losses. However, this is possibly one of the worst things you can do if you simply let your fearful emotions take over in a market downturn and sell your positions just because you’re scared.
What happens if when your emotions take over, you happen to sell at the bottom of the market downturn and the market starts to recover and you miss out on the recovery? Plus, you never really “lose” any money until you realize gains or losses by completing a sale of a stock.
Even though you don’t realize gains or losses until you sell, it may be necessary to sell either to lock in profits or limit losses.
Greed is also a deadly emotion that can be one of many investing pitfalls that one might encounter.
Imagine a stock runs up 30% in two days and you’re super excited, hoping that the run will continue and you’ll be able to make 100% or more on this one stock.
So you keep the stock, but in the coming weeks, the stock plummets 60%. Now instead of being in the green, you’re in the red. The previous greed you felt before is replaced with massive fear and you sell based on fear and realize a loss in the end.
Too much greed can be the downfall of man, and in this case, can be the downfall of your stock portfolio.
Lock in profits and limit losses
Typically, if you are saving for retirement, and you are several decades away from retirement, you have little reason to sell positions unless you are reallocating assets. This is because you have time on your side and time typically favors those who wait, even if there is a market downturn, the recovery that generally follows goes above and beyond.
At the same time, it allows you to increase share position in stocks at cheaper prices during market downturns.
You may at certain points in your investing career, to lock in profits. After all, you don’t really realize any gains until you actually sell your shares.
Typically I like to lock in profits for stocks I am not going to hold forever at 40% increase. Oftentimes, I do find that 20% is a much more reachable/manageable increase to be able to lock in profits. You can even just lock in a portion of your position at 20%, then if it continues to rise, sell more to lock in another portion at 30%, and so forth.
On the flips side of the coin, it may also be prudent to ensure you limit your losses by setting a loss limit of 10% (your limit may be different from mine). This limit ensures that the maximum you would lose from any one particular position in a stock would be 10%.
10% is a small number compared to 50% or even 100%.
Something else to keep in mind, is that if a stock drops 10%, it takes roughly an 11% increase to bring it back to what it originally was before it dropped.
My investing pitfalls
My biggest investing pitfalls are that I still let emotions run my investing to an extent. Granted, I have gotten a lot better in systematically and logically doing my investing, I still find it hard to limit my losses and lock in my profits.
A recent example is a highly volatile biotech stock that was up 10% and I figured I should probably sell it to lock in the profits and figured I could buy back in when the price drops, but my 9-5 job obviously took precedence. So, I was unable to take time to put in a sell order for that profit lock. In the coming days, the price of the stock dropped 20%, but I still hold on to this stock due to the nature of the stock itself.
Oil is another great example this year, with the price of oil falling enormously from the start of 2015 and shares of oil companies dropping to 52 week lows. I probably should have sold some of my positions to limit my losses much earlier and bought back in as oil was rebounding back, but I was a little bit too late.
Granted, I was still able to sell before it completely hit bottom and was able to buy back in at a lower price point and kind of made out even right now, it would have been a lot smarter to have limited my losses earlier.