Investing is hard, but you don’t have to make it harder! Here are three investing mistakes that you should do your utmost to avoid to make sure you don’t lose your retirement savings.
Mistaking cheap price for value
Everyone knows that to be a successful investor, you need to buy low and sell high. However, such a simplistic adage obscures the fact that not everything that is cheap is good value. The market is full of highly-motivated, intelligent people with access to a lot of data, so if a stock is falling in price, you need to have a very good reason for taking a chance on it. Having a contrarian streak is important, but so is knowing when the market is correctly pricing a stock.
Stocks that look like they are good value, but are actually cheap for a reason are called ‘value traps’. They look like a great buy, but in reality end up never recovering in price.
Excessive leverage is a classic hallmark of value traps – some businesses take on high levels of debt in order to fuel expansion, which is fine as long as earnings are growing. If growth stagnates, however, it can become difficult to pay down the interest payments and principal debt. If your company’s cash flows are being consumed by a debt mountain you may want to reconsider investing.
Repeating the same errors
I don’t think it’s controversial to say that making money in the stock market can be difficult. The learning curve is steep, and you need to put real-life savings on the line. Additionally, any number of things can happen – from accounting fraud to geopolitical unrest, there are always dangers that can plague the investor.
You can minimise the impact of such unexpected events in two ways: by being prudent in your allocation of capital, and by learning from your own mistakes. There’s no shame in making a mistake once, but repeating the same errors over and over will only lead to self-inflicted pain.
I recommend keeping an investing journal. In it, you should detail every stock purchase and sale, along with the reasoning behind why you did what you did, what your emotional state was, and how the trade ended up working out.
Doing so will allow you to identify what works for you, and also to pinpoint potential blind spots and negative behavioural patterns. Perhaps you are guilty of overtrading, or aren’t diversified enough. Keeping track of your decisions will serve you well over time.
It’s all well and good to know, on an intellectual level, that speculating by buying expensive stocks will likely lead to disappointment and loss. It’s another thing to restrain yourself in a bubble when everyone around you is getting richer. There’s a reason why ordinarily rational people get sucked into speculative manias.
Poor discipline is one of the leading reasons why many people fail to make money in the market, in my opinion. They get pressured into following the crowd, and lose the ability to independently assess their actions, which is ultimately almost always a recipe for disaster.
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Neither Stepan nor The Motley Fool UK have a 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.