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Financial investing follows several straightforward principles to ensure your investments increase in value.
To put it simply: you make sure you understand what you invest in, you don’t put all your eggs in one basket and you never risk more than you can afford to lose.
However, the world of investing is a little bit more complicated than that and it is easy to make mistakes when you first start out.
In this post, you will be introduced to five common investment mistakes and how to avoid them.
1. Investing in something you don’t understand
Probably the worst mistake any investor can make is investing in something you do not understand.
If you read about a new type of financial product or see an advert promising high returns but you aren’t quite sure how these returns are created, then you should not invest in these securities.
When it comes to investing it is best to keep it simple. Stick to stocks, bonds, commodities such as gold or oil (the gold price has been interesting to watch lately) and investment funds (such as ETFs, Mutual Funds and Index Tracker Funds).
2. Failing to diversify
Diversification refers to investing into a range of securities, as opposed to putting all your eggs in one basket by simply investing in one or two stocks.
According to StarlingCapital.com Analyst Carlos Lopez, “the right level of diversification has been proven to reduce overall investment risk without reducing investment returns. Hence, diversification is the only ‘free lunch’ you will get in the financial markets.”
An easy way to diversify your investment portfolio is to buy Index Tracker Funds or ETFs (exchange-traded funds), which invest in a basket of securities for you. That way you can gain a low-cost access to a diversified portfolio of stocks, bonds or other assets.
3. Investing using debt
If you receive a ‘hot stock tip’ or are very sure that a certain company or sector will outperform over the next six to twelve months it may be tempting to take out a loan and use that money to invest.
However, investing using debt is a horrible idea.
Not only will your investment need to return you more than the cost of the loan, but also, if the investment turns sour you have debt you now need to pay off, which will way on your financial situation.
4. Not paying attention to fees
Another common investment mistakes that beginners regularly make is not paying attention to investment and trading fees. High investment fees have a very negative effect on your long-term investment returns.
For example, if your investment fees are 2% per annum and your portfolio returns you 7% per annum, then your actual return is only 5% per annum. The difference in portfolio values between 7% average annual return and 5% average annual return over a ten-year period is $20,097 and $16,470 – around $3,500.
However, it is not only fund fees to keep an eye on. Overtrading, and thereby generating trading fees, is another way to reduce your investment returns long-term.
Be mindful of how often you make changes to your portfolio and do not let emotions drive you to move in and out of your investments during market corrections. Remember, as an investor you are in it for the long run.
5. Not investing at all
Perhaps the biggest investing mistake one can make is not investing at all.
The way to build wealth is through taking what you are earning and investing a part of it. Whether you invest your excess income in your own business, in real estate, in collectibles or the financial markets.
It’s important to start investing, even if only with small amounts, as soon you start earning an income.
The reason for that is the power of compound interest. The sooner you start to invest, the more interest you will earn not only on the original amount you invested but also on the interest you generate each year.