Are you guilty of making investing mistakes? Most of us are, so don’t feel bad. The best thing you can do is read up on common investment mistakes so that you can try to avoid them in the future. After all, sometimes the best investment philosophy is just the one with the least amount of mistakes.
Give credit to the Financial Planning Association for inspiring this article. They gave their 740 members that are all financial planners a poll asking them choose the biggest investing mistakes that they see the most in their practice. I took the ideas from this poll and have added a little commentary for each. The list is ordered by the mistakes committed most often, so the mistakes at the top are considered more common than those at the bottom.
Not Having a Long Term Plan
The biggest investing mistake, according to financial planners is that investors don’t have a long term financial plan. Hmmm, seems a little biased to me. After all, financial “plan” ners make a living by selling financial plans. Maybe all of their desire toward financial plans have helped propel this investing mistake to the top of the list. I do agree that this is an investing mistake though, and here’s why.
Most people start saving money based on what they can “afford”. For each person, that means something different. I’ve heard people making $100,000 a year say that they can’t afford to put any money into their 401k. The problem with saving what you can is that it may or may not be what you “need” to save. By creating a financial plan that estimates how much money you’ll need to save for retirement and for big things like your children’s education, you can back into the amount of money that you’ll have to save right now. It will give you a goal and will help you make the right lifestyle decisions so that you don’t fall behind on your financial goal.
Not Saving at an Early Age
I have been pushing this for years. The importance of starting early is huge. Because of the time value of money and the effect of long term interest compounding, a dollar saved today can be as much as $15 by the time you hit retirement. Delaying your saving until you are in better financial condition is a huge mistake that people make. You should literally start saving as soon as you graduate from college or high school. Make it a habit and keep at it and you will have a much better chance of succeeding financially.
Selling Stocks When the Market Sinks
This is another investing mistake that I agree with. I’ve seen many people just give up on the market during cyclical selloffs. My brother, for example, stopped contributing to his 401k and cashed out his balance because it hadn’t made any money in almost two years. I can see the frustration, but selling stocks when they fall is really a panic move. Why, if the underlying company hasn’t changed, would you want to sell stocks after they’ve already fallen substantially. This is a form of timing the market that just doesn’t work.
Investing in the Top Performers
Okay, this is a mistake that I’m also guilty of. I’ve bought into Chinese stocks at their peak valuations. I’ve also owned Apple for quite a few years. If you only use a small part of your portfolio to chase top performing stocks and funds, then it probably isn’t a big mistake, but if you focus all of your investments on the hottest trends and buy the top performing funds, you are destined to lose more money than a diversified approach. Hot sectors and funds almost never remain at the top of the performance list for more than a few quarters or years. And often, buying them after they’ve already performed well, is a big mistake.
Assuming Current Events are Going to Continue
This can best be seen by looking back at the dot com bubble from the late 1990s. The nasdaq was so highly valued, along with so many internet and technology stocks, that people started to justify their investments by claiming a “new normal”. Then, during the great recession of 2008, I heard the same thing in a pessimistic manner. Basically, that housing prices will stay depressed for decades and that the stock market returns of the past are gone. The “new normal” is for extra slow growth for the rest of our lives. Rubbish! Historical trends don’t always repeat themselves, but try not to plan your future based only on the current trends and conditions, especially if we are in a boom or bust.
Not Contributing Enough to Retirement Accounts
In my opinion, every person that is employed and that has acccess to a retirement account, should contribute the maximum amount each year. If you are self employed or there is no plan offered by your employer, sign up for an IRA, Roth IRA, or self employed 401k plan and contribute as much as you can. Saying that you can’t “afford” to save for retirement, especially in a tax advantaged account, is not acceptable.
Early Withdrawals From Retirement Accounts
I’ve seen this happen lots of times. People get frustrated with the market or they decide that they want to spend money on something they can’t afford, and so they withdraw the money from their retirement account well before retirement. Not only does this set you back years in your retirement savings plan, but it also will cost you a lot of money in taxes. Besides paying the income taxes on all the withdrawals, you’ll have to pay an additional 10% penalty. That means that with federal, state and penalty taxes, you will likely only get to keep about half of the amount you withdraw. Also, larger withdrawals will be taxed at your marginal rate, so the more you withdraw the higher your marginal tax rate will be. Unless it is an absolute emergency, don’t withdraw money from your retirement accounts before its time.
There you have it. The seven biggest investing mistakes, at least according to the Financial Planning Association. I would also add the lack of diversification as a big mistake. Many people put most of their portfolio into the stock of the company they work for, or have the majority of their assets in their primary home. Taking big bets and not being diversified should probably be on their list.
Anything you would add to the list?