If you’re reading this article today, it is my hope that you will save yourself a lot of heartaches and a lot of money. I’ve come up with a list of seven investing mistakes that beginners often make when it comes to investing. Hopefully, if you read this article all the way through, you’ll be able to know what those mistakes are and also tell your friends about them. Not many intros, let’s get right into it.
7 Beginners Investing Mistakes
1. Timing The Market
The first mistake that I see people making is that they try to time the market. What does this actually mean? Well, oftentimes I hear a similar phrase, and let me know if you guys have heard this before. But someone says “oh god right now the market is so high, I don’t want to invest right now. Maybe I should wait for the market to pull back a bit before I invest in index funds or different types of stocks”
Alright, let me debunk this mistake for you guys right now.
Timing the market is actually not a good idea, and it’s actually been backed by data. There is an article from the Schwab Center For Financial Research titled “Does Timing The Market Work”. In the article, they compare five investing styles of five hypothetical long-term investors.
Each investor is given a hypothetical $2,000 every year for 20 years, starting in 2000 and ending in the year 2020. The first person is like a mythical savant because he times the market perfectly, which means that he buys in at the lowest point every year. Some years, that might not even be until September or October, but he does in fact buy at the lowest point every year.
The second person just takes the two $2,000 and invests it immediately. The third person dollar-cost averages into the market over time. The fourth person has the worst timing possible, as she buys in at the top every single year. The last person just stays in cash.
How Did It Go
So who do you think did the best?
If you said the first person, the person who timed the market perfectly did the best, you would be correct. He did in fact do the best. From the article’s chart below from Schwab Center For Financial Research, basically, you’ll see that the perfect timing brought in about $151,000 over. Investing immediately and dollar-cost averaging both at around 135 k, even the person who had poor timing made $121,000. The worst-case scenario was to leave it in cash.
The takeaway here is that perfect timing every single year for 20 years is going to be relatively impossible. Actually, it’s statistically impossible, and it’s really hard to predict. The next best thing that we can do is either just dollar cost average into the market, or invest it all immediately. Even if you do time it perfectly every single year for 20 years, the difference isn’t going to be astronomical as you might think. Therefore the most realistic strategy for the majority of investors would just be to invest in stocks immediately.
Just in case you think you’ll regret buying in at the top, just dollar cost average into the market. That means you pick a specific interval of time and buy the same amount of money into the market every so often.
The old saying “time in the market beats timing the market”, is actually statistically backed up by data. And hell, even bad timing does well.
There is one scenario in which you would want cash, just in case you want to make a big purchase in the next one to two years like a house. In that case, you might want to not risk your money in the market, leaving it as cash is fine.
2. Not Understanding Fees
The second mistake I see beginner investors making is not understanding fees. If you’re investing in an index fund or a mutual fund or ETF, it’s important to know the fees involved. Mutual funds are the most popular investment vehicles and are actively managed, which means they have an active fund manager picking investments for that fund.
If you have a financial advisor or have a 401k, oftentimes they’ll try to sell you or put you into a mutual fund instead of a passively managed fund like an index fund or ETF. This is because some mutual funds are front-loaded, which means that the advisor or the 401k plan might actually make money upfront from putting you in that mutual fund.
Now, the average mutual fund expense ratio is between 0.5 and 1% versus an index fund like VTSAX, which actually has an expense ratio of 0.04%.
While these fees don’t seem large, the impact that they could play over the long term is going to be huge. For example, let’s say you had an index fund with a 0.09% expense ratio and the mutual fund charges 0.82%, the difference here is around 0.7% which doesn’t seem like a lot after 30 years.
How Did It Add Up
However, the difference in fees is going to be well over $15,000. You might be wondering, well, surely mutual funds charge a higher fee because they do better. That’s actually not the case. Some mutual funds do better, but the majority actually do not. According to Morningstar which is one of the top websites for mutual funds and index fund research, “only 24% of all active funds topped the average of their passive rivals over the 10-year period ending in June 2020”.
That means three times out of four, you’re not doing better than an index fund and you’re paying a high amount of fees. The lesson here is to always check the expense ratio before you invest, the lower the better.
Lots of Vanguard funds are actually quite low because Vanguard isn’t a for-profit institution, they pass back those cost savings to you in the form of their index funds. Fidelity also has a suite of zero-cost index funds for you to invest in.
I hope you’re enjoying the article so far, the next few mistakes are going to be really crucial to your investing foundation, so keep reading.
3. No Foundations
The third mistake I see beginners making when it comes to investing is that they don’t have an emergency fund, and they don’t have their foundation covered. A lot of people are really eager to get invested in the market, which I totally get, it’s really fun and you can make a lot of money.
But if you don’t have a safety net, you’re going to be investing with scared money, and scared money is typically emotional money. This means you might make poor decisions when it comes to investing, costing you way more money in the long run.
It’s always a good idea to have between three to six months’ worth of expenses saved up in a savings account, that you do not touch, absolutely do not touch in case of emergency.
The last thing you want to do is get invested in the market, have an emergency happen to you, and then have to sell your investments early to cover that emergency. Not only are you going to be killing your long-term gains, but you may also owe short-term taxes on those gains.
The 2008 Crises
Back in 2008, during the financial crisis, a lot of people just liquidated their investments so that they could have cash on hand to cover bills, or maybe pay for expenses because they didn’t have a proper emergency fund set up. Just because they liquidated their positions in 2008, a lot of those same people missed out on a huge bull run in the following years.
Ideally, you’re investing with money that you’ve set aside just for investing, and that money can work for you and grow in the market over a long period of time.
4. Lack Of Planning
The next mistake I see is not having a plan in mind. When it comes to investing, you want to understand the reason for your investments. Do you want cash flow, do you want to retire early and just grow your portfolio as quickly as possible, do you have an appetite for risk or are you a more risk-averse investor?
By having a plan in understanding yourself, investing actually becomes a lot easier because you might be able to limit yourself to certain investments by knowing who you are. In fact, limiting yourself can be somewhat freeing because it means that you won’t invest in something that you don’t understand.
The Pareto.s Principle
Personally, I’m not a Yolo type of investor, you won’t see me buying options, contracts, or penny stocks, I just know that about myself. As a result, I’m not even going to spend time researching options or even small penny stocks that can get me into a lot of trouble. I’m a big fan of the 80/20 rule or Pareto’s principle, that rule just says that 80% of the results typically come from 20% of the inputs.
If I do spend time researching stocks and investments, it’s usually trying to find high-quality growth stocks in the tech sector that I think will be still around in the next 5 or 10 years.
Before you start investing, I would suggest assessing your goals and time horizon and being as specific as possible. Let’s say you want to buy a $300,000 vacation home in 20 years, if you have this specific goal in mind, you can actually come up with the plan and work backward to achieve that goal.
Oftentimes, what I’ve found is that you don’t really need to bet your entire portfolio on risky investments If your time horizon is long enough. Also, you might not even need the craziest maximum return, once you have your plan down you can research different strategies for your situation, and what suits you.
5. Day Trading Without Experience
The next mistake I see people making when it comes to investing is that they fall into the trap of day trading. If you take time to analyze the trading behavior of day traders, you’ll find out that basically, everyone lost money, and seriously I mean like everyone. That’s because if you’re day trading, you’re literally competing against the people that do it for a living.
Not only that, if you day trade, you’re naturally at a disadvantage because of the tax implications of short-term capital gains. That means that any profit you make while day trading is going to be taxed at your ordinary-income rate.
For you to profit and actually beat a long-term investor with day trading, you have to consistently outperform the market, plus roughly an extra 20% for taxes.
What You Should Do
What should you do instead of day trade? Well, we already talked about some of the ways today, but one strategy is just to invest in ETFs and Index funds known for their low fees. You also want broad diversification, because if you’re diversified enough, you’re not really flirting with disaster too often.
If you’re a day trader consistently only trading a few stocks or companies or industries, you actually might be too concentrated and could lose a huge chunk of your portfolio at any given moment.
Lastly, passive investing is just simply easier, it saves you time, performs better for the majority of investors, and so on.
6. Following The Crowd
Don’t follow the crowd or investment experts, even people in a discord group or even people on YouTube that are suggesting to buy or sell a certain stock at a certain time. Even if that person that you’re following is really wealthy say Warren Buffett for example, sometimes Warren Buffett can be wrong as well, and sometimes their investments might not make sense for your portfolio either.
You want to be able to think for yourself, and you want to invest in stuff that you understand completely and can reason through. I would also be really cautious of anyone online trying to sell you an investment course, or basically make you pay a membership fee to get access to better stock picks.
In general, if they’re selling you a course on how to get rich or how to trade, they’re the ones getting rich and you’re the one that’s paying $500 or $1,000 for information that you could probably find online for free. At the end of the day, don’t listen to other people when it comes to investing. That even means your mom or your dad, it’s the biggest risk to your portfolio and they aren’t going to be right all the time.
7. Not Using Tax Advantage Accounts
I’m talking about IRAs, Roth IRAs, 401ks, and Roth. By buying your investments in these tax advantage accounts, you could actually save a lot of money. For example, with a Roth IRA, you contribute to it with after-tax dollars, but, because of this, that means all your gains are going to be tax-free by the time you withdraw it at the age of 59 and a half.
With tax rates ranging from 15% to 40%, taxes is actually one of the largest burdens on anyone’s portfolio over time. The more that we can shelter our gains from taxes, the more money that we’re going to make over time, and the happier we’re going to be.
A lot of beginner investors might choose a trading app like Robinhood, Public, or Weeble, which is fine for a taxable trading account. But you want to at least make sure you have at least one tax advantage account. You can do that at a large firm like Fidelity, Wealthfront, or Vanguard.
Also oftentimes, employers will offer you a401k through their providers. So if you have some money invested in those tax-advantaged accounts for the long term, you’re in a good position.
In terms of priority, investing in a taxable account should be the last priority for anyone if you can shelter your taxes do so while you can.
That’s It’s It
Alright guys, I hope that this article helped you out. Which mistake are you guys making the most? Let me know in the comments. Make sure to subscribe to my mail list to get notified of updates from my blog. Peace and Happy Hustling!