Many beginner investors tend to make the mistake of entering the stock market without any financial education or prior research. It is also common to see novice traders expecting to make high profits and fast, something of an overnight get-rich scheme, only to realize it isn’t as easy as initially thought, and that there are several things that can go wrong.
Even though this may sound discouraging, there are ways not to fall for them, firstly, by acknowledging them. In the following guide, we will go through each of these common investing mistakes that beginners tend to make, explain what they are, and give tips on how to avoid them.
Starting investing without a strategy or a plan can cost a lot of money, and even a single simple mistake could undo the previous decisions and hard work. That is why education, research, knowing the basic rules of investing, and common investing mistakes are essential before starting.
As one of the most famous investing quotes goes:
“It is remarkable how much long term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” – Charlie Munger.
As you start your investing journey, it is crucial to remember that people learn their whole lives. Acknowledging the fact that you are still learning instead of trying to be knowledgeable from the start can save you a lot of money and avoid stupid and avoidable investing mistakes. Now, let’s get down to business.
Investing vs. Stock trading
Investing is an act of buying assets or securities with the aim they will grow in value over time, for example, stocks, bonds, real estate, or commodities – a notion of putting money to work to make existing money grow.
One of the ways is stock trading, a process of buying and selling stocks of publicly-traded companies short-term to increase money invested over time. Stock trading is thought of as a riskier strategy, whereas investing in bonds, for example, is safer but with much lower returns.
Another way is to do your own research and purchase individual stocks through the stock market. But before you start, it is essential to know common beginner investing errors to maximize profits and minimize risk and losses.
17 common beginner investing mistakes
It isn’t uncommon to see a beginner investor make mistakes due to inexperience, at the same time being overconfident. The mindset of money will grow either way or simply hope it will just work out. This attitude, however, can result in some pretty significant losses, so it’s better to pay attention now than regret things later.
Important: After reading these common errors investors tend to make, you’ll have a better idea of the techniques to apply. It will also help to comprehend what kind of investor type you are, what kind of a strategy is better suited for you, and which one will be the most effective.
Here are the most common investing mistakes:
1. Not educating yourself before you put money to work
A common blunder is that only a few investors do their due diligence before moving into the market. One shouldn’t underestimate the time, education, commitment, and dedication that goes into being a stock trader, let alone being a successful one.
Financial education and knowing the basic accounting processes can help get a well-rounded picture of investing and trading. How money works and making money work for you isn’t taught in schools, so not educating yourself prior is the number one mistake to avoid.
2. Expecting to get rich overnight
When entering the stock market, many dreams of quick gains and high profits. However, the reality is that while it is indeed possible, it takes time and effort to build wealth through stock trading.
Set reasonable expectations and make sure to leave room for error. Don’t put all your savings into stocks, as it may take even a few years to recover if things won’t go as planned. For example, the market’s average annual return is usually around 5%, but this number can fluctuate, some years increasing to 15% and some years dropping to 15% – be prepared for the market volatility.
3. Basing your investment decisions on gut feeling and emotions
When people get excited about a specific stock, they might make rash decisions based on their gut feeling and buy into something that isn’t as good as it sounds and worse on paper. That’s why digging deeper and checking the company fundamentals is always a good idea.
Both beginners and experienced investors can make the mistake of purchasing stocks based on emotion. For instance, the driving force could be greed, taking a high risk and expecting a high reward, buying stocks that are actually overvalued. Losses are more significant when things go wrong with overvalued stocks than undervalued ones.
It is easy to fall in love with a business and forget why you are investing in their stocks which are to make a profit, so make sure to check the company fundamentals still, and if any of them have hinted to you things aren’t as good as they sound, re-consider the purchase.
4. Investing before you are financially ready
Consider that stock trading comes with highs and lows, and for some periods, for example, during bear markets, you might be losing money. Investing is a long-term game, so leave some emergency funds to hold out the lows.
What is more, never invest if you are still paying off any high-interest debts. People likewise lose money in stock markets if things go wrong and the proceeds aren’t always guaranteed, and you don’t want to end up being even more in debt at the end of it.
It is good to save some money for rainy days, as you never know when unexpected costs may occur. For example, an unanticipated medical bill or house repair costs, when the stock market happens to be down, there is no money left for unexpected occurrences.
5. Not doing on your own research
Herd mentality is when people base their decisions on other people’s opinions and conclusions, go with the crowd, and it is common in investing.
However, it can be dangerous for new investors who trust the market trends, e.g., hyped-up or “trending” stocks, which might be overvalued due to high demand. Avoid the typical mistake and don’t solely rely on financial television programs and hot stocks; always check if the stock is as good as others say.
6. Not knowing the basic fundamental factors
Another common mistake is not knowing the fundamental factors and what makes the market go up and down.
For example, one primary indicator is supply and demand – if the demand goes up in a bull market, the supply goes down, which raises the prices. Vice versa, during economic downturns or bear markets, the demand goes down, putting too much supply in circulation, thus bringing down prices.
A common mistake is making irrational decisions based on impatience, leading to premature selling. Investing is a long-term game, and a slower approach to portfolio growth can generate better returns in the long run, so investors should remain patient in situations where the overall market drops or individual stocks go up and down in value.
For example, during the Covid-19 pandemic-induced crisis in March 2020, the stock markets collapsed, only to bounce back a month later quickly. Many sold, but those patient enough to see how markets reacted benefited.
When individual stocks are down, always first check if there is a specific and explainable reason it went down in value, it can often be temporary. For example, if a company faces supply chain issues and a lack of raw materials, the business is likely to bounce back after supply shortages. However, if something bigger at play hints at long-term problems, thinking about selling might be a good idea.
It is common for investors to lose patience and keep selling during market volatility. However, sometimes looking beyond short-term price fluctuations can be the winner. Be prepared to take some losses over an extended period without selling. Moreover, setting realistic goals regarding profit growth can help to remain patient – the market will be volatile and unpredictable no matter what.
8. Buying penny stocks
Penny stocks trade for less than $5, often even less than $1, which makes them so appealing to novice investors. But the fact that investors could afford to buy thousands of these stocks doesn’t necessarily mean they will generate any profits, quite the opposite.
There are four types of stocks clustered based on their market cap:
- Penny stocks: trading for less than about $5 a share, highest risk investments;
- Low-cap stocks: between $300 million to $2 billion in value, generally higher risk as companies are younger, but could also offer higher returns;
- Medium-cap stocks: between $2 billion and $10 billion in value, medium risk, offer a good balance between growth and stability;
- Large-cap or blue-chip stocks: are over $10 billion or more market cap, larger and more stable enterprises, generally risk-averse, however lower returns.
Note: Penny stocks generally carry high risk, are often unprofitable, volatile, and not from established businesses as they are easily manipulated by scammers who target them with so-called “pump-and-dump” schemes. It means buying shares of a stock and promoting it to drive up the price, making it seem like an excellent investment but leaving investors with significant losses.
9. Not diversifying
Not diversifying one’s portfolio is an investment blunder novice investors tend to make often. It might be tempting to make things easy and buy just a few stocks that you think have high growth potential, but if either of the stocks crashes, it has a much more significant effect on the whole portfolio than on a diversified one.
Overall, you don’t have to go crazy buying hundreds of different stocks. As a general rule of thumb, anywhere between 10-20 stocks in various sectors is proven to be a perfectly good number, with no more than 5% to 10% allocated on each investment.
10. Investing in companies in industries you don’t understand
One way to diversify your portfolio is to invest in companies across several industries. Still, it is necessary to note that it is best to do so in sectors you understand. If you are familiar with a specific sector, it is easier to know what gives that business a competitive advantage, when they thrive, and why they are likely to keep growing.
For example, if you are sufficiently familiar with what Amazon (AMZN) or Nike (NKE) do and what macroeconomic aspects would affect their stock prices and growth rates, investing in the e-commerce and retail sectors would make sense. However, if you have no idea about the financial services industry, it might be harder to anticipate what affects the growth of finance companies.
If you still see the potential in a specific industry, a good solution is to build a diversified portfolio through exchange-traded funds (ETFs), mutual funds, or index funds.
11. Forgetting transaction fees
Novice investors don’t often think about the transaction costs and taxes that come with trading. Jumping between investments, buying and selling too often can be a profit killer because of high trading commissions – fees that brokerages charge for selling your positions.
These fees should be no more than 2% of the overall trade because to make money, one also has to grow by the extra 2% before making any profits. For example, if you place a $100 order and the commission is $7, it represents 7% of the total purchase, and to break even, your investment has to grow by a complete 7% first before becoming profitable.
Even though short-term active trading can generate good profits, it requires more time, education, and risk than buy-and-hold strategies. Sometimes, you need to give time for investments to grow.
The Securities and Exchange Commission (SEC) has warned that many day traders typically suffer financial losses within the first few months. Therefore, long-term investments might be more sensible and are recommended for beginner investors, and can generate the same returns overall.
12. Expecting good performance to continue forever
Another common mistake is relying on positive past performance or failing to monitor whether that performance is carrying over year after year. Depending on historical performance should serve as a risk indicator, and one should consider other metrics along with it.
For example, some stocks may surge or even double in value one year, but for one reason or another, that success doesn’t necessarily reflect the year after.
A fast-growing company might see high gains several years in a row due to a new competitive and unique product, however, failing to innovate and bring new products to the market later on.
13. Failing to regularly evaluate portfolio’s performance
Even though it’s a known fact that investors should assess their portfolio’s performance regularly, it is yet another typical mistake people new to investing tend to make. Doing so will help refine and adjust your investing strategy and track what generates the most value to get better over time.
For instance, if you have decided on a buy-and-hold strategy, it doesn’t mean you can forget about it and expect them to grow. Regularly evaluate your investments: check quarterly financial reports, monitor news about the company, if they are still growing in sales, or whether they have released or planning to release any new products or services.
For example, you assess your portfolio’s performance and discover your individual stock portfolio generates the same or fewer returns as an S&P 500 index fund. It might make sense to invest the money there or to rebalance your portfolio if necessary.
14. Letting your emotions get the best of you
Both beginners and experienced investors tend to let their emotions affect their decision-making. Even though that is entirely normal and common, it is crucial to first recognize that you’re acting out of greed or fear to keep these emotions in check and avoid making rash decisions.
For example, patient investors may benefit from those who have sold their stocks prematurely through irrational conclusions. Things like panic selling due to fear during a bear market and economic downturns are common.
Even though there is no way to desensitize or avoid the emotional connection to money, you can choose an investment strategy that fits your risk tolerance or start investing with smaller sums. Both can help to minimize losses as well as emotional distress. Gaining experience can also boost confidence and skills levels, thus reducing worries and the emotional side of things.
15. Not using index funds
Buying individual stocks takes more time and commitment than investing in index funds. Index funds require less knowledge, skill, and time than investing in individual stocks, so they make an excellent choice for beginner investors. Often, beginner investors wouldn’t learn about them, which is a mistake to avoid.
In a nutshell, index funds are a combination of stocks that mirror the performance of a particular market index, for example, the S&P 500.
They are passively managed and come with lower fees than actively traded funds. A specific example is The Vanguard Total Stock Market ETF (VTI), which puts your money across the US market. Index funds can generate similar returns and offer a great way to diversify one’s portfolio.
16. Trying to time the market
Another common investing mistake in trading is getting out and buying back investments at the right time. Investors keep their stocks when the market is rising and sell to invest in safer options like saving accounts and cash equivalents during bear markets.
However, this kind of strategy requires tracking the market and knowing exactly when to sell and when to repurchase the stocks, which is extremely difficult. So, as a beginner investor, it can be even better to stay invested even during the market ups and downs rather than try to time the market, as overall, it can generate the same returns.
17. Investing without a strategy or a plan
The golden rule in stock trading: Plan your trade and trade your plan.
When trading stocks, it is understandable that one needs to have a clear overview of their investments. Stocks go constantly up and down, and without one, it is impossible to control what is happening in the market.
As a beginner investor, first, have a plan. Emotions can run their course, and everything can naturally get overwhelming, especially when money is involved. For example, if you opt to invest in individual stocks, value stocks, growth stocks, or put your money to grow in index funds.
Consider your personal risk tolerance, how much time you can realistically allocate on trading and research, and how much you are willing to invest.
It takes time and consideration to avoid these common investing mistakes, and even experienced investors can fall for them. While not entirely avoidable, being aware of them can help make better-informed decisions to maximize profits and minimize losses.
To be successful at investing takes a lot of education, research, commitment, and time. Keeping yourself updated about the latest news, regularly reviewing your portfolio, and having a plan will help you avoid the common investing mistakes and have a better approach. And it is essential to remember that people learn from mistakes, start small, be aware of the typical errors, and gain some experience.
What should a beginner investor learn?
First and foremost, a common investing mistake is not doing any or enough due diligence or research before investing. Before doing any trading, learn the basics to get a well-rounded picture of how money works and how to make it work for you.
How to avoid emotion when investing?
Another typical investing mistake in investing is letting your emotions get to you, even though that is completely normal and both experienced as well as beginner investors tend to do so. It’s important to keep those emotions in check to avoid making rash decisions by first acknowledging them. Recognize you may be acting out of fear not to sell your stocks prematurely when the market starts to go down. Gaining experience by investing in smaller sums can boost confidence levels and desensitize the emotional connection to money.
Can you get rich by investing?
Investing in the stock market is a definite way to generate wealth, but the high potential also brings increased risk, and even though possible, it isn’t as easy as it sounds. People dream about entering the market in the hopes of earning high profits quickly. In reality, it takes time and effort to increase wealth through trading. So, to avoid this common way of thinking, acknowledge that things won’t happen overnight and set realistic goals and expectations to avoid disappointment.
Why is it important to diversify?
Diversification is a common rule of investing, yet many still make the mistake of hedging their bets on a few select stocks, or only stocks in the same industry. Make sure to have at least somewhere in between 10-20 stocks across different sectors in your portfolio to reduce the risk, in case one stock or the entire industry crashes.