Key Takeaways
- A dearth of financial education, combined with ill-informed advice from peers and friends, can be deleterious to one’s financial health.
- Proper risk management can result in improved decision making and a sharper assessment of investing tradeoffs, helping to maximize value.
- Emotional investing commonly involves fear, greed, brand attachment, or herd mentality, and can result in unwise investment decisions.
Investing offers several benefits. It can enable people to grow their money, provide steady income, achieve financial independence, support causes close to them, and leave a legacy to their heirs. There are risks, however. In general, the higher the potential return, the more that risk goes up.
Still, if investors can avoid making common investment slip ups, they can grow and protect their investments. Here are the five investing mistakes investors want to avoid.
Mistake #1: Lack of Research and Understanding
It is too often the case that people invest with minimal – if any – knowledge about investment options other than traditional investment tools such as recurring deposits, national savings, certificates, and fixed deposits and the like.
A dearth of financial education, combined with ill-informed advice from peers and friends, can be deleterious to one’s financial health. This underscores the importance of conducting thorough research before investing, which not only helps with decisions, but will allow the investor to develop a sound investment strategy that suits their needs and goals.
While there is a risk of what is called familiarity bias in asset allocation, since such bias can keep the trader prejudiced against the unknown, there are also risks associated with investing in unfamiliar assets.
That is why part of investment research and understanding involves market trend analysis, a powerful tool that can help identify buying or selling opportunities, reduce risk, and improve portfolio performance.
Mistake #2: Emotional Investing
A second major mistake is emotional investing since emotions can negatively impact investment decisions. Such emotions commonly involve fear, greed, brand attachment, or herd mentality. Dumping all one’s stocks early in the pandemic, for example, may have seemed wise back then, but many investments are long-term instruments that are known to rebound over time.
It is also common for investors to home in on investment fads or hot securities and assume more risk than is needed to achieve their financial objectives. A problem is that such investors become overconfident when markets are strong and then panic when they are declining.
A more disciplined investing approach is encouraged, meaning the investor has a robust, evidence-based strategy to meet goals, reduce risk, and minimize costs. Disciplined investing means forming good habits and then performing them consistently.
Mistake #3: Market Timing and Overtrading
This mistake involves trying to time the market and overtrading. As a strategy, market timing means making investing moves by seeking to predict future market price movements. Such predictions may be based on technical or fundamental analyses that offer an outlook of market or economic conditions. Predictive methods for making market timing decisions may include quantitative, technical, fundamental, or economic data.
Many financial experts, academics, and investors themselves, though, contend that it is impossible to time the market, while others strongly believe in market timing, which is different from “time in the market.” The latter refers to a strategy in which the investor does not attempt to guess when the market is at its apex or lowest point. Instead, they buy with the understanding that while their timing is likely off, the fundamentals ultimately matter more than timing.
This means that the “time in the market” investor will stay with the market until they have reached their planned goal – nearing retirement, for example – or until their first reasons for buying change. The top reasons why time in the market is superior to market timing include:
- There is no crystal ball. Stock prices in particular are unpredictable. Even if they were predictable, it would still be challenging to profit from investments because the market price would not stray from what everyone has determined will be the securities’ future prices.
- Trying to time the market is an emotional rollercoaster. Markets and stock prices are inherently volatile, fluctuating dramatically every day. Market timers, then, may be tempted to unload their investment too soon to gain a small profit, or to avoid a loss, even though their original reasons as to why the security may grow remain the same.
- It can be expensive. Combined with overtrading – trading frequently without a plan –attempting to time the market can result in exorbitant brokerage commission costs.
A better investing approach may be to pursue a long-term approach that is based on research and understanding.
Mistake #4: Neglecting Risk Management
Risk management is the practice of pinpointing prospective risks in advance, assessing them, and acting to curb them. Proper risk management can result in improved decision making and a sharper assessment of investing tradeoffs, helping to maximize value. The opposite is also true. Without a sound risk strategy, profits can be lost in just one or two poor trades.
There are three main types of risks: market, credit, and liquidity. Market risk refers to the possibility that an investor will experience losses due to factors that affect investments’ overall performance. Credit risk, meanwhile, is the possibility that an issuing entity will default on a loan. It is the uncertainty a lender faces. Then there is liquidity risk, which is the risk of being unable to buy or sell assets over a given period without negatively affecting the asset’s price.
There are ways to manage risks, including:
- Setting stop loss orders. This is a risk-management tool that, once a security reaches a certain price, sells it. It aims to limit losses in case the asset’s price falls under that price level.
- Diversification. (covered below). Spreading one’s portfolio among varied investment vehicles can mitigate risk.
- Asset allocation. This is the manner in which an investor “weights” their investments to meet their financial goals, factoring in the individual’s tax situation, time horizon, and risk tolerance.
Mistake #5: Lack of Diversification
In the worst-case scenario, an overly concentrated portfolio can get wiped out with a single event. On the other hand, having diversified holdings can be an effective way to manage such risk. What diversification does is lower asset-specific risk – owning too much of one asset class or type – relative to other investments. In fact, portfolio diversification is among the critical elements of a sound investment approach.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Learn more about the ways Yieldstreet can help diversify and grow portfolios.
Summary
Yes, investing is risky. However, if one can avoid making the above mistakes, the investor can mitigate such risks and potentially reap the benefits of putting capital into assets with the expectation that the securities’ value will heighten over time.
What's Yieldstreet?
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.
2 Represents an net annualized return, using an internal rate of return (IRR) methodology, with respect to the matured investments shown in your Portfolio experience, utilizing the effective dates and amounts of subscriptions and distributions to and from the investments, net of management fees and all other expenses charged to the investments.[read more]