Investing Mistake 1: Spreading your investments too thin
Over the past several decades, Wall Street has preached the virtues of diversification,
drilling it into the minds of every investor within earshot. Everyone
from the CEO to the delivery boy knows that you shouldn't keep all your
eggs in one basket - but there's much more to it than that. In fact,
many people are doing more damage than good in their effort to
diversify. Like everything in life, diversification can be taken too
far. If you split up $100 into one hundred different companies, each of
those companies can, at best, have a tiny impact on your portfolio. In
the end, the brokerage
fees and other transaction costs may even exceed the profit from your
investments. Investors that are prone to this
"dig-a-thousand-holes-and-put-a-dollar-in-each" philosophy would be
better served by investing in an index fund
which, by its very nature, is made up of many companies. Additionally,
your returns will mimic those of the overall market in almost perfect
lockstep.
Investing Mistake 2: Not accounting for time horizon
The type of
asset in which you invest should be chosen based upon your
time frame. Regardless of your age, if you have capital that you will
need in a short period of time (one or two years, for example), you
should not invest that money in the stock market or equity based mutual
funds. Although these types of investments offer the greatest chance for
long-term wealth building, they frequently experience short-term
gyrations that can wipe out your holdings if you are forced to
liquidate. Likewise, if your horizon is greater than ten years, it makes
no sense for you to invest a majority of your funds in bonds or fixed
income investments unless you believe the stock market is grossly
overvalued.
Investing Mistake 3: Frequent trading
I can name ten investors on the Forbes list, but not one person who made
their fortune from frequent trading. When you invest, your fortune is
tied to the fortune of the company. You are a part-owner of a business;
as the company prospers, so do you. Hence, the investor who takes the
time to select a great company has to do nothing more than sit back,
develop a dollar cost averaging plan, enroll in the dividend reinvestment program
and live his life. Daily quotations are of no interest to him because
he has no desire to sell. Over time, his intelligent decision will pay
off handsomely as the value of his shares appreciates.
A trader, on the other hand, is one who buys a company because he
expects the stock to jump in price, at which point he will quickly dump
it and move on to his next target. Because it is not tied to the
economics of a company, but rather chance and human emotion, trading is a
form of gambling that has earned its reputation as a money maker
because of the few success stories (they never tell you about the
millionaire who lost it all on his next bet... traders, like gamblers,
have a very poor memory when it comes to how much they have lost).
Investing Mistake 4: Fear based decisions
The costliest mistakes are usually fear based. Many investors do their
research, select a great company, and when the market hits a bump in the
road - dump their stock for fear of losing money. This behavior is
absolutely foolish. The company is the same company as it was before the
market as a whole fell, only now it is selling for a cheaper price.
Common sense would dictate that you would purchase more at these lower
levels (indeed, companies such as Wal-Mart have become giants because
people like a bargain. It seems this behavior extends to everything but
their portfolio). The key to being a successful investor is to, as one
very wise man said, "...buy when blood is running in the streets."
The simple formula of "buy low / sell high" has been around forever, and
most people can recite it to you. In practice, only a handful of
investors do it. Most see the crowd heading for the exit door and fire
escapes, and instead of staying around and buying up a company for
ridiculous levels, panic and run out with them. True money is made when
you, as an investor, are willing to sit down in the empty room that
everyone else has left, and wait until they recognize the value they
left behind. When they do run back in, you will be holding all of the
cards. Your patience will be rewarded with profit and you will be
considered "brilliant" (ironically by the same people that called you an
idiot for holding on to the company's stock in the first place).
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