In this episode of the podcast, we discuss five of the most common investment mistakes people make: 1) Waiting for the “right” time to invest, 2) Anticipatory selling, 3) Buying into (or buying more of) the latest “hot” stock or investment trend, 4) Concentrating in one stock or one area of the investment universe, and 5) Chasing income, yield, or a similar theme.
For each mistake, we explain what drives it, how it typically materializes, and what you can do to avoid falling victim to it. The universal theme underlying each mistake is human behavior and emotion, which makes for an interesting discussion of how to fight our natural survival tendencies that, unfortunately, don’t serve us well as investors.
Outline of this episode
- 5 common investment mistakes (and how to avoid them) [0:32]
- Mistake #1: Waiting for the “right” time to invest [1:39]
- Mistake #2: Anticipatory selling to avoid losses [7:06]
- Mistake #3: Buying into the latest “hot” stock or investment trend [11:11]
- Mistake #4: Concentrating in one stock or sector of the market [16:15]
- Mistake #5: Chasing income, yield, or a similar theme [19:50]
- The recap [23:36]
Mistake #1: Waiting for the “right” time to invest
Someone who is waiting for the “right time” to invest has cash sitting on the sidelines that could be invested for a future goal (i.e. retirement) but is reluctant to invest it. We are proponents of keeping some cash on hand for day-to-day living expenses, an emergency fund, or money earmarked for larger expenses coming up within the next year or two.
However, beyond that, you’re effectively losing money as the rising cost of living (inflation) erodes the purchasing power of money sitting in cash. So what do you do with that money? Do you use it to pay down debt? Invest it? If you’ve decided the best course of action is to invest, this is where things become troublesome. Why? Because your fear kicks in. What if you invest and your investments immediately decline in value? This fear becomes stronger as the dollar amounts become larger.
You need to set aside your emotions—to the extent that you can—and any opinions. Then, you choose the best path forward: investing all at once (the "financially optimal" approach looking purely at probabilities) or investing on a set schedule. We start by outlining your priorities and preferences to help you decide the next step to take.
Mistake #2: Anticipatory selling to avoid losses
When it comes to investing, there’s a time to take action and there’s a time to be patient and sit tight. Anticipatory selling means you’re selling because you’re anticipating an unknown future event. Emotion—usually fear—drives that decision. You hope to get out of the market before something bad (or worse) happens. Everyone tries to rationalize deciding to sell, but it usually boils down to the fear of losing more money.
With anticipatory selling, you convert a paper loss into a real loss and lose the opportunity for the value of the investment to recover. This is common during a stock market decline. If you sell because you anticipate losses, you’ll then be stuck dealing with deciding when to buy back in. It’s a vicious cycle.
Mistake #3: Buying into the latest “hot” stock or investment trend
Humans compare themselves to one another in all areas of life. If you were told that your investments were up 25% during the year, you’d likely be happy. However, if you learned that everyone else’s investments were up 75%, your feelings would change. You’d question why everyone else was up so much more instead of being happy with what you have.
People buy into the latest hot stock or trend because they don’t want to miss out on a good opportunity. But you can’t let greed overtake your emotions. Chasing the latest “get rich quick” idea doesn’t usually pan out—it’s likely too good to be true. Most people join the party late after the best returns have already been realized. You must remember: Past performance is no guarantee of future performance.
Mistake #4: Concentrating in one stock or sector of the market
You have to fight the temptation to give in to greed and chase what has done well recently. This has been more relevant in the last decade (from 2010–2020) with the growth of tech companies like Amazon, Apple, Tesla, Facebook, etc. after a decade with a 0% return for the S&P 500 (caused by the tech bubble bursting).
There are long periods where an investment, country, or sector of the stock market can do really well—or really poorly. Some investments may grow to become a large portion of your overall net worth. But when the shoe is on the other foot, that paper gain can quickly disappear.
That’s why you don't want to overly concentrate in one stock or industry and should diversify your investments.
Mistake #5: Chasing income, yield, or a similar theme
Everyone has a desire to have a guaranteed return on their investments, especially if they’re nearing retirement. But chasing income or yield means you’re chasing “promised” income from an investment or product. That might mean investing in stocks that pay high dividends, high-yield bonds, real estate investment trusts (REITs), or rental real estate. While there are benefits to income and yield, the mistake happens when you chase these things without regard to your total return.
Secondly, you need to ask: Why is an investment offering a higher yield than others? Because for the potential of a higher return, you may have to take on more risk. Chasing yield produces a less diversified portfolio. You need to look at the total return on your investments (interest, dividends, and market appreciation) and find a balance you’re comfortable with.
Resources & People Mentioned
- Episode #48: Lump Sum of Cash to Invest – All at Once or Gradually?
- Episode #53: How to Manage Your Retirement Paycheck During a Market Decline
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup