Common Investment Mistakes (And How to Avoid Them)

March 25, 2010, By Jeff Waddle 0 comments

It’s hard to find anyone these days that hasn’t made a costly mistake in the recent stock market swings. Yes, serious money can be made in the stock market and it’s done every day. But, you also can lose your shirt if you’re not careful—ask anyone who had money in the market on October 19, 1987 when the Dow Jones Average dropped more than 20% in a single day, or during the painful nosedive that came in 2008.

So, unless you’ve got money to burn, avoid these common investment mistakes. Doing so will make your financial future a lot brighter.

Underfunding your 401K: when the Federal government and your employer work together to give you money, take it. With the Feds giving you a tax break and your company matching your 401K contributions, there is no better way to save for retirement. Most companies have a few investment options to choose from, so look them over carefully and seek advice on what is the best plan for your unique financial circumstances.

Trying to time the market: everyone wants to be the smart guy who "buys low and sells high" but if you try to time market trends, you might end up doing the exact opposite. Remember the dot.com boom of the 1990s when it seemed that any Internet-related tech start-up’s stock would keep soaring into the stratosphere? A lot of people tried to catch that wave’s crest and hit bottom instead when the boom went bust. Yes, there are boom and bust cycles in the stock market, but remember that annual returns in the stock market have averaged around 10% over the past century, so holding quality stocks or mutual funds for the long term is usually the smart strategy.

Overreacting to market swings: sure, you can hold onto a stock too long but most people err on the side of selling a stock too quickly during a market dive. Swings up and down are part of the market’s normal cycle, and panic selling when the market is down is a sure-fire way to lose big. Remember, you haven’t lost money until you actually sell a stock, so it may bounce back if you give it some time to do so. On the flip side, some stocks are losers and will continue to be, so you’ve got to have the courage to sell stocks at a loss if circumstances warrant it. A trusted financial advisor can help you make those difficult decisions.

Investing money you’ll need in the short term: there is no surer way to fall victim to the "buy high, sell low" syndrome than investing money in stocks that you might need in the near future. You should approach stock market investments as a marathon, not a sprint, because in the long run, investors have historically ended up ahead. Short term, the results can be all over the place.

Acting on advice from friends who aren’t investment professionals: everybody knows someone who thinks he’s now a market guru because he made a few bucks on a stock and consequently thinks he’s qualified to offer you investment advice. If the stock tip sounds too good to be true, it probably is. Keep in mind that you’re ‘buying’ something, so you need to heed the age-old advice: Buyer Beware. If you want advice, ask an investment professional.

Not diversifying: being too heavily invested in a certain industry might deliver better results if it’s booming, but it also exposes you to higher risks on the down side. Along with the dot.com bust of the 1990s, the recent slump in the automotive industry is a good example. Being diversified in a wide range of industries, corporations and even global markets can help insulate you from market fluctuations. That’s why many individual investors prefer diversified mutual funds over individual company stocks.

Not having a plan: having an investment strategy that establishes your risk tolerance, financial need projections and assets you have available for long-term investments is key to avoiding panic selling, rapid portfolio turnover and other actions that can spell disaster for your financial future. Again, seek the advice of a qualified financial planner and once you create a plan, stick to it. Your bank account will thank you.

Jeff Waddle is a featured contributor to ManoftheHouse.com.