Learning to ride a bike when you are young comes with some risk at first. You could fall and get hurt, ride into a tree or worse.
Yet once you get the hang of pedaling and steering, the world is suddenly your oyster. You can go anywhere there are flat roads or sidewalks and race back home before dark.
Investing is similar in many ways. Those first few ideas you have about how to grow your money feel tentative. A down day or a bad week in the market can be nerve-wracking.
But time is a great teacher. If you can recover from early missteps, seeing a steady, growing investment balance can be empowering, like that first day you pedaled right down the driveway and up the street — no looking back!
Here are five mistakes new investors typically make and how to avoid them in the first place.
The whole point is to buy low and sell high, right? But what if you buy a hot new tech stock, only to watch it crash and burn shortly after you get in?
It happens to everyone, so don’t fret. The thing to remember is that no stock, no CEO, no broker or friendly tipster owes you a win. If you buy a stock and expect only upside, you shouldn’t be buying stock at all.
How to avoid it: Rather than putting all your eggs in one basket, buy a diversified fund of stocks. If you really want to own tech stocks or even something narrow, like solar energy companies, there are specialized exchange-traded funds (ETFs) that trade only in those shares. However, they own dozens or hundreds of them, not just one company.
You see a fund manager interviewed on TV and he seems to know his stuff. His track record over the past 12 months has been exemplary, and you just like his way of thinking. So you buy the fund.
Only later do you realize that the manager’s strategy is far more high-risk than you would like. The fund’s valuation rises and falls dramatically week to week. So you bail out at a small loss.
How to avoid it: There are a ton of stock “X-ray” services online that can help you understand the relative risk of any given manager’s approach to investing. Chief among them is Morningstar. You could also read the fund’s prospectus, a legal document that lays out the fund’s management style and holdings in detail.
Fees are the biggest Achilles heel of long-term investing. An actively managed fund that charges a 1% fee takes 1% of your investment balance each year, irrespective of performance.
That means that if the fund returns zero for a given year, you lose money 1% of your investment anyway. If you invested $100,000, that’s $1,000 out of your account and gone forever.
How to avoid it: Research has shown over and over that the majority of actively managed funds trail the stock market as a whole. Owning a low-cost index fund gets you the index return at the lowest possible cost, allowing your gains to compound more quickly.
Some young investors distrust the 401(k) they are offered at work and instead try to buy stocks directly through apps or online brokerages. That can be entertaining but ultimately it’s a costly hobby.
That’s because your company very likely gives you free matching money just for saving the minimum into your 401(k). Once you consider the tax break from using a 401(k), that’s a lot of free money you give up for nothing in return.
How to avoid it: Always put in enough to get the match and do more if you want the tax break to be bigger. Your taxable accounts can wait.
New investors love the idea that they can somehow get the inside scoop on a stock that will allow them to retire early. Remember, though, that by the time you hear something on TV the real traders have taken up a position to profit from your ill-considered and late reaction.
How to avoid it: Invest regularly and in the same dollar amounts, month in and month out. Tune out the chatter and just let the short-term traders beat each other up. You’ll do better and sleep better, too.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.