Everybody plans to have a great future. Any one who thinks about securing their financial future will have to consider and undertake some type of investing. The investment could be in real estate, business, stocks, shares or even in bonds. The fact is, the stock market in most countries has proven to be one of the most resilient and robust investment and wealth creation vehicles over the long-term.
However, despite that, the majority of people end up either losing money in the stock market, or never really truly understanding how to benefit from the upward, long-term movement of the stock and share market.
What is the Stock Market?
According to Investopedia, the stock market refers to the collection of markets and exchanges, where regular activities of buying, selling, and issuance of shares of publicly-held companies, takes place. It connects investors who buy and sell stocks (shares representing ownership in a company) in a controlled, secure, and managed environment.
Are you looking to make an investment in the stock and share market? Here are the nine most common investment mistakes people make, preventing them from ever making money in the stock and share market.
1. Having No Plan
How can you hit a target if you have no idea what you are ultimately aiming for? Investing in the stock market without any type of target or objective, becomes a casual dabble.
Can you imagine going to a travel agent and saying that you want to fly without giving them a destination? Well, that’s exactly how people usually approach the stock and share market, which is why they never learn how to benefit from the long-term upward movement of the stock market.
You need to understand that the stock market is fundamentally a good investment for only some people, and typically if people have a long-term horizon. Meaning that they’re prepared to invest money for over 10 years, they know how to diversify that money, but they also understand that they require a sufficient mix of other assets. So, by investing in the stock market, they’re positioning themselves for future growth of wealth, but they’re also positioning themselves to have more liquidity in their investment portfolio.
2. Not Understanding Stocks
One of the most common investing mistakes that a lot of people make is they don’t understand what stocks and shares really are. A stock is not a piece of paper. You’re actually buying a stake in a company, but many people don’t see it like that. That’s why the level of engagement that investors have with the stock market is extremely low.
Rather than looking at it as a quick money-making machine, you have to understand that you’re essentially using your money to buy a share in a real company that sells products and services.
When people don’t understand stocks, they don’t research the underlying company in which they are investing. This means, they see the act of investing as just putting some money in the stock market somewhere.
Not understanding that investing in stocks means investing in real companies, results in people’s level of engagement dropping. Which ends up with people making wrong decisions.
3. Attempting to Time the Market
Another fundamental investing mistake that people make is attempting to time the market. That simply means that they’re trying to pick the best time to enter the market, and the best time to exit the market. Many people attempt to get into the markets when they are going up, and they attempt to get out when they are going down.
It sounds like a smart thing to do, however it is very challenging to implement. Even Fund Managers, professional investment companies who have been doing this for many years, can’t get it right. Therefore, it begs the question if professionals can’t seem to master this, can individual investors really do this consistently and successfully?
The individual investor who thinks that they’re somehow going to be able to time the entry into and the exit out of the market, immaculately has no idea that this is a very big challenge, because you have to get two decisions right. Decision one is knowing when to enter the market, and decision two is knowing when to exit the market. If you falter on either of these two decisions, you effectively don’t end up making money, but worse, you may end up losing the entire amount of money you initially invested in the stock and share market.
4. Failing to Diversify
Many people who do invest in the stock market are not properly diversified, meaning they are facing high concentration risk. Many times investors may have a collection of shares in companies, but that does not necessarily mean they are diversified. For diversification to happen, one needs to follow the rule of negative correlation in finance. That simply means the companies you’re invested in, should not all act in the same way to events that take place in the industry or the market.
A person who is properly diversified, will give due consideration to the fact that diversity can only happen when you have a spread of companies across different industries, geographies and across different company sizes, in order to minimize concentration risk.
When people are overly concentrated in the stock market, there is a slight possibility that they may make a killing and do very well. However, there is a higher probability they are going to get killed. If all of your money is invested in one or two or even three companies, meaning your portfolio is not properly diversified, when the markets go down, or when one or two companies go bankrupt, you stand to lose a big proportion of your money (if not all of it!).
5. Panicking During Corrections or Crashes in the Market
Another mistake investors make is that they panic when there is a correction or crash in the market. It is very common for the financial markets to go up and down in the short to medium term.
That up and down which is also referred to as volatility, can impact people emotionally. Many people don’t understand that stock markets are proven to be very resilient in many countries over the long-term, as long as investors buy good quality businesses and they diversify well. Yes, the markets can be unpredictable in the short to medium term, and it is not uncommon for a correction to happen every 6 -12 months, or for a major crash to happen every 3 -5 years.
You can also have black swan events, which are completely unexpected events, where the markets can crash quite significantly. Since many people who invest in the stock market don’t understand how markets perform in the long-term, and do not have a long-term horizon, unfortunately they end up panicking and selling at exactly the wrong time.
6. Falling in Love with the Company
This is also a common investment mistake that people make when they invest in the stock market. When you fall in love with a company, you can become very biased towards that company. This means you might not objectively assess the financial performance or the condition of that company, resulting in an emotional decision to invest in the company.
You may either end up being over-concentrated, or neglect the fact that the company share price is inflated. By doing so, you may remain invested even when the company’s prospects are not looking good. This could not only reduce your return on the stock market, but you also miss out on the opportunity cost of investing in other companies.
7. Not Reinvesting the Dividends
When it comes to investing in the stock and share market, many people do not reinvest the dividends. This can be a big mistake for the long-term investor. According to some studies, most of the compounded returns on the stock market is made through reinvestment of dividends.
The really smart investors go one step further, which means they diversify their portfolio, and when a company produces a good dividend, they don’t always reinvest that dividend back into the same company that produced it. They may take that dividend and reinvest it back into another company. The benefit of doing this is that if you have a portfolio of stocks, and one company has done very well in that portfolio, but the other hasn’t performed well, it typically could make sense to buy more stocks in the company that hasn’t done well, because it’s simply trading at a lower price.
Unfortunately the majority of investors do not reinvest the dividends back, or they end up reinvesting back into the company that produced that dividend, even if the company stock price is expensive. This could be a mistake because it could result in them compromising the return, and had they been smart about their dividend reinvestment strategy, they could have optimised.
8. Speculation
A mistake that is all too common when investing in the stock and share market is speculation. This means that the investor makes very little consideration to the underlying company, and the quality of the company’s assets and management. More attention is given to making predictions in the market and buying purely with the intent to buy low and sell high. More consideration is given to the share price and less consideration is given to the intrinsic value of the company in which the shares are being bought.
Many traders do this, however it needs to be understood that trading and speculating is not the same as long-term investing. Trading and speculating carries a lot more risk than investing. Speculating is usually done by people who are wanting to make a quick return. Mostly, it does not go well and people end up losing money.
“If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.” ― Peter Lynch
9. Buying and Selling Too Often
A common mistake that investors make is they buy and sell too often. This could be a problem because of the cost involved in buying and selling frequently. If your shares have made money and you sell, you pay capital gains tax.
If you’re constantly buying, you’re paying brokerage fees. If you add the cost of tax and brokerage fees on the frequent turnover of your portfolio, you will find that a good fraction of your return has been eroded by those costs. Buying and selling too frequently is one of the fastest ways to erode stock market returns.
“The stock market is designed to transfer money from the active to the patient.” ― Warren Buffett
To become a good investor, you have to first understand why most people fail when it comes to investing in the stock and share market. When you know the problem, you can take measures to ensure that you don’t commit the common investing mistakes that people make, which prevents them from ever making wealth through the stock market.
By understanding and avoiding the reasons why losses typically happen, you can set yourself up to make gains in the stock and share market.
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