The reason nonprofessional investors often err was well known even before the new science of investment psychology was born: we’re only human, and something happens deep within us when we’re handling our own money that doesn’t happen when we’re handling someone else’s money. When it’s our own, it’s the vehicle for realizing our dreams and warding off our waking nightmares, and every decision we could make looms larger than life.
Here are 10 of the most common mistakes individual investors make while trying to do the best they can:
- Falling in love with a stock. There are a host of reasons for this, among them being we or a relative worked for the company, we inherited it, we like being associated with the company’s prestige, or simply that it’s been a steady performer for as long as we’ve owned it. The problem is, however, that the stock won’t fall in love with us and won’t think twice about losing half or more of its value. This is a case where love makes us blind to deep flaws in a company that may never be repaired.
- Catching a falling knife. When a high-flying stock goes bad, it drops fast and hard. But when it does, there are thousands of investors who think it’s a steal and buy shares when they see it bounce. What they often learn is that they caught the stock in midfall, and like a knife passing right through the palms of their hands, the stock price has a lot farther to fall before finally coming to rest.
- Investing on tips. The problem with tips is that the average investor hears them after just about everyone else already has. As a result, we buy the stock at its highest price, and no one wants to buy it to make it go any higher.
- Chasing performance. For many people, stocks only get attractive after they’ve gone so high for so long that they’ve reached the end of their run. This is also called rear-view mirror investing, meaning you’re more concerned with where the stock has been than where it’s going.
- Failing to diversify. It’s smart to spread out your risk, not only among more than one stock, but in more than one industry, sector, country, and asset class. The more diversified you are, the less risk you’ll bear.
- Thinking only short term. This is actually the opposite of investing. It’s speculating. There are few part-timers who succeed at this game. The danger is that just like changing lanes too many times in a traffic jam, you’re just as likely to fall behind where you might have been had you just stayed where you were.
- Playing penny stocks. Inflation hit true penny stocks years ago. The strict definition is stocks priced less than $5 a share with daily trading volumes of less than 100,000 shares. Usually, the companies have net tangible assets of only a few million dollars and a short operating history. The odds of hitting it big with these are about the same as winning the lottery, if not worse. Owned mostly by individual investors and the founders of the company, penny stocks are notoriously volatile and risky.
- Waiting to break even. It’s been said that more money has been lost by investors waiting to recoup their initial investments than for any other reason. Successful investors know when it’s time to cut their losses and look for a better opportunity.
- Being too conservative. This syndrome is the opposite of most of the previous mistakes. In this case, investors are so afraid of losing money that they fail to put enough money in growth vehicles to stay ahead of inflation. As a result, the buying power of their portfolio declines year by year, courting the risk they’ll have a lower standard of living the older they get.
- Investing without a plan. This is another way of saying all of the above. Sound financial plans match your income, resources, and risk tolerance with an investment strategy providing the discipline that can take emotions out of the equation.
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