Like any skill, becoming good at investing requires time, effort and a willingness to learn from your mistakes. The last of these is arguably the most difficult. No one likes to dwell on their failures for too long, especially those that also involved losing money. That’s why I recommend learning from others as much as possible.
Here are four things most experienced investors know that hold people back from stock market success.
1. Not having a plan
Failing to understand your reasons for investing is a classic error. “To get rich” isn’t specific enough. “To be as rich as… (insert name of celebrity/neighbour/arch-nemesis here)” should also be avoided.
So, let’s get real. Identifying a financial goal — be it saving for a house deposit, a child’s university tuition fees, or retiring from the rat race early — has huge implications for your risk tolerance and subsequent investment strategy. It can mean the difference between focusing on established blue-chip companies that pay dividends to high-risk, high-reward, small-cap stocks.
Another thing to recognise is that circumstances change. Financial planning is, therefore, a fluid process.
2. Doing what everyone else does
While some derive intellectual pleasure from it, active investing (a.k.a picking stocks) is only really worth the trouble if you’re able to beat the market. That’s hard, even for fully-resourced professionals, hence why so many get an average return by following the herd.
Then again, wise private investors know they have a few things in their favour. With no requirement to justify their salaries on a regular basis, they have the freedom to zig while others zag. They can take advantage of stocks whose share prices are temporarily depressed and buy promising companies that most professionals are prohibited from touching. This makes it easy to generate a return that’s different from the market.
There’s just one key point to realise from going your own way. You also need to be right.
3. Failing to diversify
Many fortunes have been lost on the failure to spread money around. That’s why embracing diversification is so important. Throwing all your cash at one set of businesses because you believe that sector will outperform could lead to huge returns, but the reverse is also true.
Failing to diversify even on a macro level can compromise returns. Since the depths of the financial crisis, the FTSE 100 has increased 90% in value. The US stock market, by constrast, is up roughy 280%!
Investors choosing to cast their net to include stocks from over the pond would have likely got a far better return. Like most things in life, balance is recommended.
4. Ignoring costs
Performance can be less-than-optimal even if you manage to pick the right stocks because of the costs involved.
That you’ll generate charges is the only outcome you can be sure of when you’re investing. The more active you are, the bigger they’ll be since every buy/sell instruction to your broker involves paying commission. It’s worth bearing in mind that doing as little as possible can often be the most profitable strategy.
Another consideration is tax. Wise Fools know that holding stocks outside of an ISA or SIPP means paying tax on whatever you make. This can have a huge impact on how much money is compounded over time and what the result will be at the end of the journey.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.