Most Common Stock Market Investing Mistakes
If you were an investor in the first few weeks of February of 2018, you probably want to visit a place like Anger Room.
“Redirect your frustrations and take it out with us…safely.”
It’s a real thing.
The huge swings in stock market performance may have you wondering if you’ve made some huge mistakes, and that’s normal when investing tensions are running high. To assess whether or not you’re on track, here’s my list of the most common mistakes investors make.
Forgetting your investing goal (or not having one at all)
For starters, go back to the reason you started investing in the first place. Specifically, how much money were you trying to accumulate, and for what purpose? How long were you planning to invest?
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Let’s assume, for example, that your investing now in a 401(k) retirement account, and that you’re 25 years from retirement. You’ll willing to take a moderate amount of risk. If your portfolio is up or down 10% in one year, you can live with it. A 25% change, however, makes your palms sweaty. You invested in mutual funds, with 70% in stock and 30% bonds.
That’s the plan- and that’s where you start.
If you’re recovering from a financial setback, this article may help.
Unrealistic expectations
As of 1/22/18, the Dow Jones Industrial Average (DJIA) closed at an insane 26,214.60, up 32.4% in the last 12 months. The DJIA is an index of 30 large corporate stocks. A broader index, the Standard and Poor’s (S&P) 500, closed at 2,832.97 on 1/22, and this is an index of 500 large stocks- a bigger basket of stocks. The S&P 500 is up 24.7% over the last 12 months.
Crazy, record-setting performance… and it’s stressful to consider the fact that every bull market ends. Expecting a 25%-plus annual return is simply not realistic.
It may seem like everyone around you is getting rich- but that’s normal. In every bull market I’ve seen since the ’87 market crash, most of us think that everyone else is making a pile of money.
But there’s a trade-off. The people who are really killing it in the markets these days are taking more risk (Bitcoin, anyone?). They either have larger percentage of their total portfolios in stock (vs. bond or cash), and they’re buying riskier stocks- stocks that have less of a performance history of earnings and sales.
You need to keep your head and realize:
- Your goals haven’t changed
- Bull markets, historically, come to and end at some point
- When (not if) the bull market ends, you may incur some losses in the short term
But you can get through it.
So, what’s a normal return?
So, what’s a “normal return” on stocks, if such a number exists? Seeking Alpha (a site I highly recommend) has some great stats on historical returns for the S&P 500 from 1928 to 2015:
- Over 88 years, the S&P 500 went up 64 years and went down 24 years.
- The worst return was -43.84% in 1931 (ouch) .The best return was 52.56% in 1954.
- The mean return (think average) was 4122%
So, what’s normal? Seeking Alpha says 11%, and other stats suggest 8-10% over a 70-80 year period. The point is that 24-32% isn’t normal.
Accept the fact that, over the long-run, you’re not going to earn more than the historical “normal” return.
Risk assessment
Most investors do not honestly assess risk tolerance. Note that word- honestly. To assess your risk tolerance, ask yourself this question: If your portfolio’s value went up or down 10% in one year, is that something you could live with? How about 20%?
You get the idea.
Use that knowledge to select your investments. If want a stock mutual fund with moderate risk, read the fund’s investment objective and check the fund’s historical performance. Specifically, check out the fund’s beta, which measures a fund’s volatility in comparison with the broad stock market, such as the Standard and Poor’s (S&P) 500.
Succeeding once is random
Ask that guy who just hit 21 playing his first hand of blackjack at a casino. He may think he’s a genius, but the law of large numbers removes randomness. Over time, the blackjack player’s results will shift back to a normal level. In the same way, great investors succeed over the long term- when returns are no longer random.
Final thoughts
- Have an investment plan, and avoid emotional decisions (particularly sell decisions)
- Invest in companies that consistently make money- and hold those stocks
- Timing the market doesn’t work over the long-haul, so don’t try it
- Diversity- it’s not just an old wooden ship. Diversify your portfolio into stocks and bonds that perform differently in up and down markets. That approach will help you average out your total returns over time.
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
Co-Founder: accountinged.com
(email) ken@stltest.net
(website and blog) https://www.accountingaccidentally.com/
(you tube channel) kenboydstl
This post was originally posted on my Quora page. This post is for educational purposes only.
Image: Bullseye, Jeff Turner CC by 2.0