Warning: Big investing mistakes can be hazardous to your wealth.
One or two basic blunders can undermine years of diligent saving and crush your dreams of building life-changing wealth.
Financial professionals see investors make such errors all the time. Recently, they identified the most common of these mistakes as part of the 2020 Natixis Global Survey of Financial Professionals.
Following are some of the costliest mistakes investors likely made in 2020 — and how to avoid them going forward.
When the coronavirus swept into the U.S. this spring, it sent the economy into a tailspin. The S&P 500 index plunged 34%, likely taking much of your wealth with it.
Bear markets feel like a body blow. But throughout history, new bull markets always have followed downturns. That is why hitting the panic button and selling in bad times is usually a mistake.
During this spring’s plunge, the market fell to a low on March 23. But if fearful emotions caused you to sell on that day, you missed out on one heck of a party that followed.
From March 23 through April 9, the S&P rose a stunning 25%. The 100-trading-day period after March 23 marked the best S&P performance since 1933, with a rise of more than 50%. And stocks have continued to soar ever since.
As stocks tanked earlier this year, investors in the U.S. sold $327 billion in mutual fund positions, according to Strategic Insight. The lesson? In investing, emotions can be your enemy.
Timing the market
Let’s return to the bear market of last spring. As stocks were falling, prognosticators everywhere were rising up, telling you exactly what to do with your money.
Chances are, a few of them were right. But likely, it was very few.
Timing the market — which requires knowing exactly when to buy and precisely when to sell — is all but impossible. Numerous studies have shown that almost nobody consistently times the market well over the long haul.
In his book “Common Sense on Mutual Funds,” legendary investor John Bogle — creator of the world’s first index mutual fund — wrote:
“The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has done it successfully and consistently.”
Not recognizing risk tolerance
There is no way around it: Investing is risky. Over time, the stock market rises. But there are periods — some of them long — when equities crater.
Just in the past 20 years, the S&P 500 has seen three large stock market declines, according to Investopedia:
- Beginning in March 2000: down 49%
- Beginning in October 2007: down 56%
- Beginning in February 2020: down 30%
In each case, markets recovered. Sometimes, the recovery was relatively quick. The bear market of 2020 was a blip, lasting just one month.
But in other cases, recovery was a slog. The bear that growled its way onto the stage in March 2000 stayed put for 31 months.
Natixis points out that 56% of investors say they are willing to take on risk to get ahead, yet more than three-quarters say they really prefer safety over investment performance.
So, before you invest, understand exactly how much risk you are willing to take — and what you will do if things do not work out as planned.
It’s a safe bet that if you are reading this article, you hope to get rich someday. Or, at least you hope to achieve some measure of financial security.
Here’s the good news: If you save diligently and invest wisely over time, you will almost certainly increase your wealth — possibly to levels that exceed your wildest dreams.
But doing so takes time. Trying to make a quick killing in the market is likely to leave you disappointed. So is expecting wildly high returns of 20% annually.
Be patient. Keep your short-term expectations modest, and let the long term take care of itself. As we wrote in “10 Characteristics of Wildly Successful People“:
“If you aren’t willing to put in the hours and make some sacrifices, you might as well get accustomed to mediocrity. The best things in life — whether that’s money in the bank or a great relationship with your spouse or child — typically come only with significant effort.”
Taking too much risk
As we pointed out earlier, uncertainty is part of investing. It is difficult to get rich without taking on some risk. Money Talks News founder Stacy Johnson is fond of saying you can’t get a hit from the dugout.
However, taking on too much risk can lead to disaster. It’s important to strike a balance. As Stacy says, you should never invest money you will need in the next five years, and you should not invest everything you have into the market — ever. He writes:
“One rule of thumb I’ve been advocating for decades is to subtract your age from 100, then put the difference as a percentage of your money in stocks. So if you’re 20, you can invest up to 80% in stocks. If you’re 80, 20%. If you’re nervous, invest less. It’s just a rule of thumb.”
For more, check out “7 Ways to Slay Your Fear of the Stock Market.”
Not recognizing the euphoria of an up market
When times are good, it is easy to think sunny skies will stretch on forever.
Investors who see a 10% gain in stocks over a period of six months are much more likely to expect their investments to continue to rise in the future, according to research from the Natixis Center for Investor Insight and the Massachusetts Institute of Technology.
But while it may seem counterintuitive, the more stock prices rise, the greater the danger is that a fall is on the horizon. By contrast, when stocks have plummeted — and nobody wants them — they are likely to be a safer purchase.
Those truths are at the root of one of the stock market’s oldest maxims: “Buy low, sell high.” But instead of trying to figure out when to buy and sell, simply invest for the long haul.
As legendary investor Warren Buffett says, “consistently buy an S&P 500 low-cost index fund. Keep buying it through thick and thin, and especially through thin.”
Failing to think about taxes when selling
Ah, taxes: They are preferable to that other famous “inevitable” in life (death), but they still stink.
Most of us try to keep our tax obligation small. But as the folks at Natixis point out, each time you sell stock shares, you are locking yourself into paying taxes on any gains you may have accumulated. According to Natixis:
“Three-quarters of investors may say they consider tax implications when making investment decisions, but their behavior in periods of stress may actually trigger unintended taxable events. For example, a big sell-off in your portfolio could lock in gains at a time when markets are declining rapidly.”
So, Natixis encourages you to think strategically before selling. Even carefully weighing which holding you should sell first can make a big difference to how much you will owe Uncle Sam on Tax Day.
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