Expensive investment mistakes you must avoid

Dear Dr Pesa,

I would like to multiply my money through investment but I have no idea where to start. I am worried about losing the money by putting it in the wrong place. There are many investment schemes coming up and I am terribly confused. What should I look out for?

Dear aspiring investor,

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Investing is one of the pillars of wealth creation. Yet unlike saving, investing can be quite tricky. Investing in the wrong venture can easily cost you your time and hard-earned money.

But investing mistakes are part of the learning process and even millionaires who are known as shrewd investors make investment mistakes every now and then. Here are some of the common mistakes investors make:

1. Not diversifying your portfolio

Don’t put all your eggs in one basket. While diversifying your investment portfolio doesn’t guarantee that you won’t lose money, it’s better to manage risk by spreading your assets across different investments.

Diversification isn’t just about acquiring different stocks, it also means investing in different industries and asset classes. This means stocks, bonds and cash instruments. As some of your investments fall in value, others will probably rise or hold steady -- which will help you offset any losses.

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2. Acting on emotions

Although investing involves an element of emotion and intuition, avoid making investment decision from a solely emotional standpoint. Emotional decisions are often tainted with personal biases. As Warren Buffet says, "only when you combine sound intellect with emotional discipline do you get rational behaviour.” Before jumping into a major investment decision, make sure that your mind is not clouded with fear, greed, jealousy, impatience, or nervousness.

For example, avoid selling an underperforming investment because of panic. Short term rises and dips are normal and being able to stay the course and withstand can pay off in the long term. “Emotional control is the most essential factor in playing the market. Never lose control of your emotions when the market moves against you. Don’t get too confident over your wins or too despondent over your loses,” advises American investor Jesse Livermore.

3. Investing in things you don’t understand

In the words of renowned American investor Peter Lynch, “know what you own and why you own it.”  You hear that others are making crazy profits from hot, trendy, and fancy investments and you too, desire to make similar investments. You probably know little or nothing about the industry, the technology and how exactly it is going to end up putting money into your pocket.

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This is how many investors end up losing their money. Investing in businesses and industries that you understand gives you an advantage over most investors. You will be able to know -- before it becomes public knowledge -- if the industry is booming, getting slower, or cooling down.

4. Investing money you shouldn’t risk

We’ve all probably heard tales of retirees who lost their pensions and nest-eggs in an investment. If you need the money for other reasons- such as education, medical care or rent- don’t invest with it.

As commodities trader Ed Seykota says, “risk no more than you can afford to lose, and also risk enough so that a win is meaningful.” Using money you can’t afford to risk makes you nervous -- leading to emotional decisions which can cost you in the long term. Have “risk money” set aside for investing to be able to make relaxed decisions not driven by fear.

5. Not doing due diligence

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If it looks too good to be true, it probably is. Many new investors are sucked into enticing “deals” which promise to make them rich and without conducting proper due diligence, they sign over their hard-earned cash.

Before investing in a company, review their financial statements, its management and ownership, and how it’s competitors and the general industry is doing. Make your investment only when you’re satisfied with your due diligence and have made peace with the potential risks.

6. Investing in last year’s winners

Many people make the mistake of expecting last year’s top performing stocks to be successful every year. However, too many factors can affect the performance of stocks and bonds including the economic health, politics and consumer habits. “The investor of today doesn’t profit from yesterday’s growth,” Warren Buffet says.

There are bad and good years for every company or industry. Instead, invest in companies with steady performance and a consistent, solid track record. During a bad year, a great company might still make losses, but at significantly lower levels than other companies. That shows they have a strong risk management system and are still a great investment.

7. Thinking short-term

“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas,” says American economist and Nobel laureate, Paul Samuelson.

Investing is a long-term plan and if you’re looking for short-term results, you might be sorely disappointed. Just like planting a seed, you must give your investments time to grow before they’re ready for harvest. This is especially important when you’re investing for long-term goals such as retirement and funding children’s education.

Too much investment turnover, unless you’re an institutional investor with the benefit of low commission rates, will also significantly eat into your profits. A slow, steady, and disciplined approach will take you further than being impatient with your investments. As Warren Buffet says, “If you aren’t thinking of owning a stock for 10 years, don’t even think about owning it for 10 minutes.”

8. Learning from the wrong sources

Yes, knowledge is power- but you must be careful where you get your knowledge from. Relying solely on recommendations from your buddies simply won’t cut it. There’s no shortage of self-proclaimed experts who peddle their opinions as educated, well-researched, and irrefutable knowledge.

An often overlooked key to investing well is to identify and isolate credible sources of guidance. Bear in mind that just because someone is featured in the media or makes a lot of noise on social media doesn’t mean they know what they’re talking about. Look for a source of guidance with sound and consistently reliable advice. Combine their wisdom with your own due diligence and intuition to make great investment decisions.

9. Timing the market

Some investors wait for an “opportune time” to buy and sell stocks. While this looks like a great idea on paper, successfully timing the market is extremely difficult- even for institutional investors. For instance, if you wait till a particular stock performs better, it will probably have reached its peak by the time you make a move.

Peter Lynch says, “There’s never been a market timer on it (Forbes Rich list). If it were truly possible, to predict corrections, you’d think somebody would have made billions by doing it.”

Instead of attempting to time the market, select high quality investments which align with your long-term goals and be prepared to hold them for a while- even when the markets are volatile.

10. Failure to harvest winnings

Back to the farming analogy, not reaping your crops when the time is right can lead to losses. Every investment has a life cycle and as it nears the end of its life cycle, keeping it longer will not make more money and can even result into losses.

When an investment makes a substantial gain, it’s usually best to harvest. This is known as the cash cow stage and employing a harvest strategy at this point will give you maximum returns.

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InvestmentDr PesaMoney saving tips