The journey to becoming a savvy investor is often paved with investing mistakes. But if we proceed with a bit of intelligence, we can gain a lot of wisdom from the mistakes of others, and not just make our own.
This may not be a movie, but I’d like to begin with the disclaimer that “any resemblance to real and actual names is purely coincidental”. But the below story has happened to many investors, including me. Let’s see if it sounds familiar to you, too.
A tale as old as time
It begins when you hear about an exciting investment opportunity from a friend. You’re not sure if you should invest or not, so you wait a couple of weeks before making a decision. The people around you and the news you read seem to talk constantly about this incredible investment opportunity. At some point, you can’t stand it anymore and decide to invest. After all, it’s hard to figure out when to invest, and it seems you could still make quick money. So why stay on the sidelines?
Reality check
But then the value of your new investment starts to go down. You find yourself constantly checking your account and checking the news. The so-called experts say that it’s probably a short-term drop and will go up again. If you are patient enough.
You’ve got no problem with that. After all, investing over the long term is important. Unfortunately, the investment’s value keeps going down, defying experts’ predictions.
You speak to your friend who recommended the investment opportunity in the first place, and he says “Yeah, I am not worried. Anyway I only bought it in a small quantity and I have other investments that are doing well”. You ask yourself what those other investments are and decide to invest in them as well. After all, diversification is not a bad thing.
Despite your best efforts to get your head around investment best practices, the market keeps going down and your investments go with it. You now face an ugly truth: you’ve lost a lot of money, and frankly, you don’t know why. You make a mental note for next time – you should only invest in something that you understand.
Down and out
At some point, you decide that you’ve had enough. You sell your investments and save the small amount of money that is left. You realize that you shouldn’t ever take more risk than you can stomach. While you are reflecting on your painful experience, you see the market going up again like it is scoffing at you. You can’t believe it, but you decide that “investing is not for you”.
Experience is the greatest teacher
It takes time to recover from such experiences. Especially because losses trigger strong emotional responses. But while first encounters with the investment world are often brutal, they tend to be the most insightful. In fact, I would argue that through that experience, you’ve learned five key investment principles to avoid common investment mistakes. Let‘s review them:
- Figuring out when to invest is difficult
In the investment world, we call this “Market Timing”. A widely held belief is that timing the markets – i.e. investing and divesting when it is the right time – is impossible.
While there is no universal proof of this, experience shows that it’s a difficult exercise. But we don’t always have a choice. For example, you don’t decide when you receive your salary or an inheritance.
The point here is that accelerating or delaying an investment decision often stems from emotional thinking. In the story above, the protagonist’s decision to invest was prompted by the fear of missing out. So before timing the markets, it is advisable to time oneself.
- Investing over the long term is important
There are multiple reasons why thinking long-term is important. First, the odds of not losing money statistically improve with time, thanks to the effects of compounding kicking in.
Secondly, adopting a long-term approach reduces the temptation to worry about short-term market fluctuations.
- Diversification is not a bad thing
Diversification can be a powerful ally if done in the right amount. It can help you mitigate the risk of losses at a reasonable cost. We’ve dedicated a full article to the power and penalties of diversification.
- Invest in something that you understand
While luck is involved in any investment success, it shouldn’t be all you’re armed with. There is a saying in the aviation industry: “you start with a bag full of luck and an empty bag of experience. The trick is to fill the bag of experience before you empty the bag of luck”.
Understanding what you invest in and having a conviction will certainly help you in bad times. And if you are not sure how an investment professional can help you.
- Don’t take more risk than you can stomach.
This is potentially one of the most important principles of investing. In fact, investing is all about risk and return. The relationship between the two is at the heart of many important financial concepts like asset allocation, portfolio construction, etc.
A new story
So, our story has taught us key principles to avoid common investment mistakes. Applying them can likely lead to a different outcome and emotional journey. Most importantly, they can help you avoid the same old mistakes and write your own investment story.
Are you looking to gain more knowledge before making your first investment? Look no further than our Kickstarter Guide – the ultimate resource for beginner investors.
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