I already shared My Biggest Mistakes Investing In The Stock Market For The First Time, losing money due to not taking care about my investments sufficiently. In the following I will summarize 10 common investment mistakes that you should avoid to maximize profits:
- Failing to define a strategy
- Having the wrong expectations
- Not understanding your investment
- Failing to diversify your portfolio
- Investing in dying companies and outdated market segments
- Missing out to take profits or to cut losses
- Jumping in and out of trades
- Trying to time the market
- Letting emotions ruin your strategy
- Not reviewing your portfolio regularly
1. Failing to define a strategy
Defining goals and sticking to a clear and well-thought-out investment strategy is a key factor for success. For many people the goal of investing is to have an additional income stream during retirement. But the goals that you define for yourself mainly influence the risks that you will have to take along the way. If you would like to become a millionaire in 10 years you will have to take far higher risks compared to someone who wants to become a millionaire in 30 years. Thus, not having a strategy and goals defined will lead to aimless investments, and you might take higher risks than needed. Please take a look at My Personal Long-Term Investment Strategy as an example.
2. Having the wrong expectations
Just investing a decent amount of money in the stock market will not make you rich. The average annual stock market return is 7-10%, in dependence on which index you refer to. Thus, in some years you will generate returns above average, maybe even 30-40%, but in others you will may lose 20-30%. Patience is the key and an investment in the stock market should always be considered as a long-term investment. The longer you hold your stocks, the more likely it is that you will generate profits from your investments.
3. Not understanding your investment
Buying a stock just because a company is hyped right now, without taking a look on the balance sheet of a company, its key metrics or its business model, is like buying a car without even knowing its features or even test-driving it. It is mandatory that you understand your investments. There is no guarantee that you will always choose the right stock to buy, but it will help you to make the right decisions in case the market conditions changes for a company, that impact its business model. Only when you understand a company’s business model and market outlook you will be able to determine whether to invest in it or at which point it is necessary to get in or to get out. A good indicator to identify whether you should invest in a company is to ask yourself, if you would start working for it. If you can answer this question with no, maybe due to the business model or future prospect, stay away from it.
4. Failing to diversify your portfolio
Portfolio diversification is more important than ever, if you only rely on the success of a few companies or a specific market sector the risk of failure is tremendous. A total loss of your investments could be the result. Therefore, it is necessary to diversify by investing in companies from different market sectors and from different geographical locations. In addition to that, investing in alternative assets like gold, cryptocurrencies or real estate can help to further diversify your portfolio. The main advantage of a well-diversified portfolio is that it will calm down your emotions in every market environment.
5. Investing in dying companies and outdated market segments
This is an important topic. Avoid buying stocks which follow a mid- to long-term downtrend. There is a reason why the market valuation has declined, either because the company is not able to grow anymore, because it loses more and more market share, or because a company is not able to transform its business model as required by the market. Companies need to be innovative to be competitive in the future. I am not talking about the approach of value investing, which is based on the idea of buying stocks that are undervalued, but about investing in companies, that fail to transform to meet future needs. Maybe from today’s perspective the company’s business might still be healthy considering its key metrics, but long-term it might lose its market share or even vanish once and for all.
In addition, avoid investing in companies from outdated market segments. Take a look at companies from the tobacco industry (e.g. Imperial Brands, British American Tobacco or Altria). Although many people quitted smoking, these companies are still cash cows with great earnings, but their stock prices have been going down for years now. Many investors and especially hedge funds do not invest in these companies anymore due to ethic reasons. Moreover, these are not companies that are considered by younger generations as a great investment opportunity.
Another example is the oil industry. First their revenues are highly depended on the oil price, which itself is manipulated by the OPEC by influencing oil supply. Do you want to invest in a company which‘s success highly depends on the decisions made by view people? Moreover, the future prospect for this market sector is not healthy, considering the current developments in the electric vehicle and green energy sector. Although I believe that oil will still partly be used 30 or 50 years from now, I am sure that the worldwide demand in oil will constantly go down over the next decades. In addition, I don’t believe that all companies from the oil sector will be able to transform their business models fast enough and thus will be replaced by new emerging companies. Think about ExxonMobil, just a few years ago it was the most valuable company in the world.
I understand that a lot of retail investors are investing in these companies, either because of their high dividend yields, or because they believe in a trend reversal. But these companies already had their boom phase. In my opinion the risk is high, and the potential rewards are low. You can still invest in these companies when a trend reversal can be seriously identified in the charts. Don’t be misled by a high dividend yield of 10-15%, because it is very likely that these companies will cut their dividend payments sooner or later (e.g. like ExxonMobil or Shell).
6. Missing out to take profits or to cut losses
If you fall in love with a company because you invested in it at the right point and have made decent profits on your position, do not miss the opportunity to realize some of your profits. Especially if a chart of a stock shows parabolic moves it is time to partly get out. If you still believe in the company’s business model and further growth, you can at least sell a portion of your position to get your initial investment back. From that point on you can hold your position emotionless because you cannot lose your own money on it anymore. In addition, the free cash from selling can be used to invest in other stocks that have great potential.
If one of your positions is deep in red, ask yourself why the valuation of the company declined and if it is likely that the company will recover sooner or later. If not, sell your position and do not wait until the stock price has recovered, because you might wait forever. Instead use the remaining funds to buy a stock with better future prospect and recover your losses by that. Don’t blame yourself that you have invested in the wrong stock and start looking forward.
7. Jumping in and out of trades
Too much trading, in particular buying and selling stocks because of short-term price fluctuations or because the short-term returns do not match your expectations, will tremendously cut your profits. Paying commissions or spread fees for every trade will significantly limit your ability to profit from your investments and in addition avoid, that your investments are able to recover. Be patient, as long as the business model of the company is still sustainable and has a good future prospect. It is nearly impossible to be profitable on every trade.
8. Trying to time the market
Waiting for the perfect entry point in the market will for sure limit your profits. Even well-known institutional investors are not able to predict the market behavior every time. But, in the long-term, considering the last 100 years, the stock market has proven to know only one direction and to always recover from crashes. E.g. in 2015, after the market had recovered from the crash of the financial crises, there were many voices predicting another market crash in the short-term. If you have hesitated to invest in the stock market at that time you have missed huge returns over the last couple of years. Thus, if you are not sure, if this is a good entry point right now, you can invest your money in several tranches over a period of one year or monthly, to benefit from cost averaging effect. But timing the market is not an option. Of course, you can try to find the perfect entry based on technical chart analysis, but this should not be the only basis for your decision to invest in a stock.
9. Letting emotions ruin your strategy
Emotions can ruin your entire investment strategy. Buying a stock based on FOMO (fear of missing out) or buying high and selling low because of fear are the main factors why people lose money on their investments. Have a clear and well-thought out strategy, stick to your plan, educate about how to read charts and the markets, don’t follow the masses, be patient and learn to deal with your emotions. Be greedy when others are fearful and be fearful when others are greedy. Buy when the market sentiment is fearful and wait when the market sentiment is greedy.
10. Not reviewing your portfolio regularly
Besides understanding your investment, it is also important to review your portfolio regularly. If you have a well-diversified portfolio, with stocks from maybe 50-70 companies, it is impossible to keep track about all of them on a daily basis, reading news or checking out their income statements etc.. Instead, define a time interval based on which you review your entire portfolio and double check if the stocks you hold still match your strategy. Plan specific dates and maybe even take a day of for that. A good starting point is to do it quarterly or biannually.
To summarize, I just would like to point out, that investing is not a no-brainer. We are talking about money that you had to work hard for, get up early in the morning and deploy 8-10 hours of your life a day. As always in life, if you want to achieve something, you have to work for it. Be passionate about your investments, be interested and enjoy it.
I hope that this article helps you to avoid some of those mistakes and to maximize the profits on your investments. You might also like: