- Everyone wants to know what the best investment is and doesn’t want to deal with common investment errors.
- Many people are trading now in the new coronavirus crisis.
- Small investors often fall into fatal traps and lose their entire capital.
- Many people buy too high and sell at low prices.
- They miss basic safety precautions.
- Stock market dreams may go to the grave for forever because of well-known investment errors.
They Don’t Want to Know Their Fatal Errors
It’s weird how few people search Google for “investment errors,” “investment mistakes,” or “avoid investment errors”, for example. Far fewer than those who search for the terms “best investment” or “cheap stocks” or “stock buying”. Maybe that’s why there are so many more poor people than rich people.
Various online brokerage firms, investing-focused startups such as Robinhood, Acorns, M1 Finance were seeing rapid growth in their assets and app downloads in the last months. (Techcrunch) Robinhood alone “added more than three million funded accounts so far this year” – wrote the company on May 4.
Why People Open a Brokerage Account Now?
Increased investment activity is common in crises and after crashes. Many people are likely to open an investment account in these months because:
01
They Have More Time in Quarantine
Now, sitting in quarantine, they have a lot more time than before. They may have had an old plan to start investing. Many want to try their luck.
02
Employees Lack of Income
Their income has been jeopardized, reduced, or they have no job at all. They hope to be able to retrain for another profession as quick as lightning. So, they will also survive as stock market speculators. Or at least they can earn some extra income from it.
03
People Are Greedy after 11 Years of Bull Market
Many small investors have seen the huge rise in stock markets to February 2020 from March 2009. (See the chart below.) They missed it and they envied it. They think it’s worth getting in finally near the multi-year lows. Although, the March lows are very far away now. Stocks in many countries no longer seem cheap, as we wrote recently. (Different in some developing countries.)
Newbies Make More Errors
Whatever the reason, many people are starting to trade now. And with that, they take a huge risk. Rookies always make a lot of mistakes. This is the case in every profession, and investing is a profession. In this extraordinary crisis times, an extremely difficult one.
No one knows exactly how long this new coronavirus epidemic will last. Nor is it clear how much damage it will cause to the economy and companies. Nor is it how stock exchange indices, the price of individual stocks, commodity markets, currencies will react. How big will be the price fluctuations, the height of the peaks, the depth of the lows? The last 11 years have been amazing – but it’s not sure at all to happen again in the next 11 years.
11 Years and Nothing Is Impossible in the Investment World
We have already learned from 2008-2009 that there is nothing impossible anymore in the markets. Everything that seemed unthinkable before became possible. For example, in the past, negative interest rates were thought by many to be unimaginable, absurd. And today it’s common in many countries. We cannot rule out that a significant part of the companies now operating will go bankrupt within a few years. But central banks and governments have taken enormous actions. Accepting rescue packages worth many thousands of billions (or several trillion) of dollars. And that can take stock indices to new highs soon.
Risks of Waves
But it is also possible that stock markets will collapse and resurrect several times in the coming years. For example, new crises may follow more and more waves of viral infection. The Spanish flu epidemic of 1917-1919 had three waves. Even today, many fear a second wave following the easing of restrictions that has begun. The possibility of a third wave has already appeared in the sensational-hungry press. Unfortunately, this is also possible.
Also, failing to produce a vaccine or an effective drug against the new coronavirus is possible. There is no vaccine against AIDS for decades. The flu virus mutates almost every year. It can also happen with the new virus.
All these risks and uncertainties are making investing more difficult and investment errors more dangerous. But which mistakes are jeopardizing inexperienced retail investors the most? In every market, independent from the virus? We’ve made a list of the most important 11+1 cases.
Investment Error 1: They Invest Their Last penny
One common investment mistake of small investors is putting all their available money in risky assets. Also the money reserves they may need soon. For example, if you are left without work, and you will need to cover your daily expenses. Or it may be necessary to repay a loan or pay health care expenses.
In these cases, forced sales can happen, often at the worst moment and price. You may sell just when the best decision would be to buy. This phenomenon is also called “forgetting your time horizon”.
Investment Error 2: Buy Stocks High and Sell Them Low
Another very common investment mistake many studies have shown. For example, researchers observed among small investors in retail investment funds. Private investors buy when prices go up and sell when they fall. Also, their reactions aren’t quick, they often react to the tabloid news, and too late.
They are seduced by high market returns near the peaks and go shopping high. Then, somewhere around the bottom of the slope, they panic at low prices and sell their shares. Of course, there are always exceptions. But without the proper experience, it is dangerous to think we will differ from the others.
Investment Error 3: Leverage Can Push You into Misery
It is a particularly serious investment error for small investors to take too much risk. Especially when they enter so-called leveraged trades, like futures, some options types, or CFDs. (CFD=Contract for difference.) Here, the amount of loss can be much greater than the money invested. A multiple. If exchange rates go in an unfavorable direction, a “margin call” occurs. Extra capital must be paid to make up for the loss. So, not only the capital of an inexperienced investor gets lost. But many times even his house or car.
Often the investment has to be sold at a terrible price due to a lack of funding. After that, the exchange rate may go in the right direction, and we could win on it. But it’s too late, the investment is over. While there are techniques such as stop-loss orders designed to mitigate losses, sometimes these don’t work either. Also, there are unfair market players who deliberately drag small investors into such dangerous deals. (Read also our previous articles: 9 Essential Ways to Prevent Investment Scam and 6 Effective and Proven Ways to Lose Your Money )
Investment Error 4: Credit Means Also Leverage
It’s important that if someone takes out a loan with a house or vacation place as collateral, this investor can still get into trouble. Even if you don’t enter leveraged trades, only buy stocks. This is because the least value of shares is, in theory, zero. In the famous Great Depression of the 1930s, the stock market in America lost 90 percent of its value to its lowest point from its previous peak. (We showed a chart here: To Buy Or Not to Buy.) A lot of companies also went bankrupt, so its price could never recover again.
So, borrowing is also leverage and can be dangerous enough. If the investment purchased from the loan loses much of its value, the loan must still be repaid. Or the collateral will be lost. And if we add shares as collateral for a loan, the position is liquidated below a certain stock price level. If the collateral is no longer enough, they sell the shares, and the credit is called back.
Investment Error 5: Investing in Dead Sectors, Hopeless Companies
It’s an old investment mistake to buy something because it looks cheap after price drops. Yet there is often a serious reason for the fall. My clever grandmother taught me this:
Granma told me that many decades before there used to be no electricity in refrigerators. They were only “ice boxes” or “ice cupboards”, not real refrigerators. They kept chunks of ice in it which they bought from a street vendor. Meat and milk were stored on this big ice blocks. Anyone who has only invested in such an enterprise has become very poor since then. Because this service has since ceased, no one sells ice on the street today.
Such businesses could go bankrupt unless they modernize their activity in time. For example, instead of ice, they started selling ice cream and frozen food. They may have also started manufacturing ice machines for use at gas stations.
After the coronavirus crisis, we will not get back to our former lives completely. Some industries may be completely ruined or shrink a lot. Some companies may survive, while others will disappear forever. Again, other companies may stay for a long time and work well. But their shares are already so expensive that it is not worth buying them.
The scissors between some sectors are already opening up enormously. Internet giants, other online service providers, many health and pharmaceutical companies are racing. (See, for example, the chart of Fiverr and Upwork here.) Aviation and tourism are dying, and a wave of bankruptcies in the oil industry could also come. Can novice small investors forecast the future of different industries? Can they choose from the sectors? I’m not sure. Even professional analysts are often wrong. They aren’t free from investment mistakes either.
Investment Error 6: Putting All Eggs in the Same Basket
A typical novice investment mistake is when someone chooses only one or two risky investments. “This company will be good, I’m very confident in that. I know how it works” – they say. Yet, as the proverb says, never put all your eggs in one basket. You can see with common sense that the risk must be shared.
This is a method known as diversification in the investment world, and it is not a luxury. So we should not invest all our money in one kind of asset (stocks, bonds, real estate, or commodities), or one market (one country, industry, or region). The worst is to choose only one stock or one commodity market product. Most recently, crude oil buyers, for example, have had a tough experience. The crude price (WTI) has plummeted from close to plus $20 to minus $40 in days. (Before in history, it was unthinkable for a commodity to have a negative market price.) Read: You Have Been Warned about the Crude Oil Hazard
Investment Error 7: Don’t Place an All-In Bet
Even if we diversify, it is still a big mistake to spend all our money at the same time. Even the richest people in the world, the greatest geniuses, can’t say exactly how long a crash or a bear market will last. It is almost impossible to catch the bottom or the top of the market. Whoever spends all their money on stocks at once, risks an even better opportunity.
It’s like diversification. But we don’t share our money between different assets, areas, and products, but also over time. It is worth dividing the capital into smaller packages and spending it in several parts. So, some capital will be available also later if prices drop further. (Read more about this method: How to Buy Cheap Stocks in the Coronavirus-crash?)
Investment Error 8: They Don’t Invest At All
But one of the biggest mistakes small investors can make nowadays is not investing at all. Because it is likely, that inflation will be higher in the coming years than before. Or if not, inflation may stay higher than the risk-free interest rates available. (Or government bond yields.) The main explanation is, that is the fundamental interest and the aspiration of states and central banks.
In crisis times, their goal is to achieve a negative real interest rate, inflating the debt. They try to avoid or temper the debt crisis. (But in the short run, deflation is also possible temporarily. That means prices fall.) (More about it: Are We Facing Epic Inflation, Horrific Real Interest, and Brutal Gold Price Explosion? And about the methods of inflation hedge: Eight Ways How Inflation Threatens Your Income and 13 Ways to Fight It) Keeping money in assets with lower interest rates than inflation has a similar effect as if the interest rate were below zero. At most, the loss is a little less.
To mid-May, from the lows in March, stocks have risen a lot around the world. We don’t know if there will be more lows. But based on historical experience, it is also likely that stocks bought in and after the coronavirus panic will prove to be a good investment. At least in the long run, in five to fifteen years.
Investment Error 9: Speculation as a Passion
Serious investment mistakes include when someone converts investing in some sports. A successful investment is often boring, it requires a lot of patience. It happens often that it’s not worth doing anything. Sitting on your cash and waiting is more rational. (This is reportedly what Warren Buffett, one of the richest people in the world, is doing lately.) Frequent buying and selling often only increases the revenue of brokerage firms and stock exchanges. But not your income.
Dangerous or intensive sports, computer games, gambling, some hedonistic pleasures are believed to produce substances that cause good feelings in the brain. A substance called dopamine is often held responsible for these feelings. Dopamine makes people feel positive, confident, strong but is addictive.
The same can happen with stock investing and other speculation types. Especially if one is speculating on high volatility assets in the short term, with high risk (mostly with leverage). When you are successful, the brain releases dopamine in the body. The investor can get to the point where he is no longer doing it for the money, but for the excitement, the passion. Many people jump in and out of investments, looking for excitement and danger. Investment companies like this, and often encourage it because a big part of their revenue flows in from frequent trading. But most small investors run out of capital and can easily lose everything.
Investment Error 10: Investors Can’t Stand the Pressure
It is a common mistake when investors misjudge their risk tolerance. Not the leverage mentioned in Point 4, but the investment psychology part. The novice small investor invests his money in an asset with the exchange rate very volatile. That it is causing a serious mental burden soon. You will be constantly nervous, unable to sleep, watching the exchange rates day and night. There is continuous trading somewhere on Earth for about 20-22 hours out of 24 a day. Asia, Australia starts it and the west coast of the US ends the day. For example, gold, oil, major currency pairs, or U.S. futures indices are almost always quoted somewhere.
Do not lose sight of your risk tolerance or your capacity to take on risk. Some investors can’t stomach volatility. Remember that any investment return comes with a risk. (Investopedia)
Investment Error 11: They Have No Plan or Goals
It is also a common mistake for small investors not to know what they are doing, what their purpose is. They are trading based on quick intuitions, questionable advice, random readings. They start something they don’t understand. Then they jump into something else that is not for them either. For example, you find many readings about the importance of stop-loss orders in the stock market. We don’t question this in the short-term trading. But for the long-term, for value-based investors, these orders may be inadequate. For example, it may automatically sell your investment near historic lows. At the point where it is a good buying opportunity in the long run.
It’s also a big mistake to have a plan, but an unrealistic one. If, for example, you think, “I have to earn $500 a month to make a living”. The market will work very differently. It will not take into account our expectations. You may suffer a loss of hundreds of dollars or thousands in the next months or years. Afterward, you could win tens of thousands on the investment in only one year – if you haven’t ruined your wealth with trading before.
The Error + 1: You Choose a Non-Existent Investment
One of the worst investment mistakes occurs even before you invest your money. It is not only about investment, but it is also about crime. Many incompetent, novice small investors get trapped by fraudsters. Most legal brokerage firms like Robinhood or Fidelity can protect users from buying shares in scammer companies. (They don’t add these to their stock list.) But others can easily fall into the trap of fraudulent brokerage firms, fake financial service providers, non-existent investment companies, fatal Ponzi schemes. We wrote two posts about this already: 6 Effective and Proven Ways to Lose Your Money 9 Essential Ways to Prevent Investment Scam
Conclusion: Learn More, Avoid Sharks
We don’t want to disappoint you with this list of investment errors, neither convince you not to invest. On the contrary, as we mentioned in the eighth part. We think we will have to invest in the coming years in most countries to keep our money’s value. (In the first line, because of the inflation and zero interest rates.) Instead, we wanted to point out that investing is important and difficult science. The more you know about it, the more likely you are to be successful. The less you know, the easier you to lose.
Learn a lot, don’t rush, and be very careful. The lesser trouble is if you don’t win money. The bigger, much bigger problem is if you lose. Because of the large investment mistakes listed, you can lose most or all your money. Sometimes, even more, than the original amount was. Better to avoid this, especially in such tough times. Don’t gift your hard-earned money to stock market sharks!
We deliberately used the word “grave” in the title, which means “heavy, hard”, but also a tomb in the cemetery. If you lose your money due to a grave error, you can also bury your dreams of investing for a long time or forever.
More Important Readings for You:
- Are You Sure You Will Buy Stocks in 2020? – Chart of the Day
- Are We Facing Epic Inflation, Horrific Real Interest, and Brutal Gold Price Explosion?
- Eight Ways How Inflation Threatens Your Income and 13 Ways to Fight It
- 6 Effective and Proven Ways to Lose Your Money
- Is It A Myth? – The Genuine Truth About Passive Income
Disclaimer
I’m not a certified financial advisor nor a certified financial analyst, accountant nor lawyer. The contents on my site and in my posts are for informational and entertainment purposes and reflecting my collection of data, ideas, opinions. Please, make your proper research or consult your advisors before making any investment or financial or legal decisions.
(Photos: Pixabay.com.)
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