Avoid these huge investing mistakes.
Even the best long-term investors will pick a dud stock every now and again or have to endure short-term market downturns that can result in temporary losses. Fortunately, disciplined, patient investors can overcome these mistakes and still make excellent investment returns in the long run. Learning from mistakes is part of becoming skilled in any part of life. But the stock market is a dangerous place for investors who don’t know what they’re doing. Here’s a look at some investing mistakes that could completely wipe out your portfolio.
Putting all your eggs in one basket.
No matter how large a company may seem or how safe a particular stock may appear to be on the surface, investing all of your money in a single company is a risky endeavor. It’s not just small biotechnology companies or Silicon Valley startups that go bankrupt. Enron, Washington Mutual, WorldCom and General Motors Co. (ticker: GM) investors all learned this lesson the hard way. By investing in a low-cost index fund, such as the Vanguard 500 Index Fund (VOO), long-term investors can avoid the possibility of a single accounting fraud or cataclysmic company meltdown costing them their entire investment.
Day trading.
Far too many new investors see the wild daily swings certain stocks make and fall into the trap of day trading. These traders assume that day trading is the shortest path to market riches. In reality, the opposite is almost always the case. According to a study by the University of California, Davis, only 1 percent of day traders use a trading strategy that is consistently profitable in the long term. Between inconsistent results and mounting trading commission fees, 99 percent of day traders are throwing away their money one trade at a time.
Investing in penny stocks.
Both the Nasdaq and the New York Stock Exchange require all stocks to maintain a minimum share price of at least $1 per share. However, on the over-the-counter market, stocks can trade for as low as fractions of a cent per share. While day traders routinely drive some of these stocks up thousands of percent at a time, the vast majority of them eventually end up at or close to zero. There’s a reason the majority of these companies are not listed on major exchanges, where companies are required to regularly report financial statements and comply with listing requirements. It may seem like a good deal to buy a stock for 2 cents, but a 2-cent stock can go to zero even faster than a $20 stock can.
Trading options.
Options trading can be extremely profitable and stock options can be an important hedging instrument for long-term investors. However, for traders who jump into the options market without understanding the risks, it’s easy to lose every dollar. In fact, one study of Chicago Mercantile Exchange data showed that three out of every four option contracts sold over a three-year period expired worthless. If a stock investment goes wrong, investors could take a 20 or 30 percent hit in a matter of months. If an option investment goes wrong, there’s a high likelihood of a 100 percent loss.
Shorting stocks.
It may seem like the risks and rewards of taking a long position in a stock and taking a short position in a stock are roughly equal. However, shorting stocks is a much riskier endeavor. When buying a stock, the theoretical upside of the investment is limitless. Potential losses, on the other hand, are capped at 100 percent because a stock’s share price can’t go lower than zero. For short sellers, that risk-reward imbalance is reversed. Potential gains are capped at 100 percent. However, if a shorted stock’s share price triples, short sellers lose 200 percent of their original investment.
Following your instincts.
The same gut feelings that can guide people so well in every other area of life often lead investors down the wrong path. There’s a long list of natural cognitive biases that every successful investor must overcome, including confirmation bias, representativeness bias and anchoring bias. Successful investors must remain disciplined in times that emotions such as greed and fear are pushing them to make the worst investment decisions at the worst possible times. Investors who make decisions based on what feels good in the moment can easily follow their instincts all the way to the poor house.
Believing any investment is a sure thing.
When it comes to investing, there are absolutely no certainties. Americans lost millions of dollars in real estate investments during the bursting of the housing bubble in 2007 and 2008. Many of these investors believed the U.S. housing market was a sure thing. Stocks, gold, oil, bonds, real estate and even the U.S. dollar have all experienced extended periods of decline throughout the years. The longer your investment time horizon, the more predictable a given asset’s behavior will be. But there is no crystal ball to see the future. No matter how solid an investment seems, it’s always safer to diversify.
Investing on margin.
Most brokerages will allow customers to borrow money to invest in what’s called margin investing. While it may seem like an easy way to amplify investment returns, margin investing can quickly turn into a nightmare. Most brokerages will allow customers to borrow up to 100 percent of their cash balance, meaning someone with $10,000 in their account can buy $20,000 of stock. Of course, that stock would only need to decline by 50 percent for the investor to lose all of his or her original $10,000. In addition, interest on that borrowed money will constantly eat into returns over time.
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The Fastest Ways to Lose All Your Money in the Stock Market originally appeared on usnews.com
