Here at the Motley Fool, we often talk about what we think good investing practice looks like. But in addition to the dos, you also have to have a good handle on what the donts are. Here are three serious investing pitfalls that you should try to avoid in order to grow your retirement savings and compound your capital.
Timing the market
Everyone wants to be able to buy low and sell high. However, some investors may (mistakenly) take this to mean that in order to be successful in the market, one must always be moving in and out of their positions. This is not so. In fact, buying and selling in anticipation of market rises or declines is a surefire way to decrease your stock market returns. There are several reasons for this.
Firstly, timing the market is hard. I would go so far as to say that it is virtually impossible. And the reason for this is not that investors lack brainpower or data. Its that in the short term, market fluctuations are almost entirely random, and can be affected by any number of variables, the sheer quantity of which makes it hard to predict. Accordingly, the decision to sell in advance of an expected market decline may be based on nothing more than a random movement.
Secondly, trading in and out of positions greatly increases your overall turnover, which leads to higher fees. Over time, trading fees can really pile up and shave whole percentage points off your ability to compound wealth.
Its also important to note that timing the market is not the same as buying and selling based on valuation. Its perfectly legitimate to sell an investment because you have decided that it is overvalued. You dont know for certain that it will decline in price once you sell it, but at least you have limited the downside risk that you face by holding it. By contrast, market timing is entirely speculative, and does not take into account what the valuation of your portfolio is.
Allowing losses to affect you emotionally
Learning to invest using stock market simulators is a decent way to prepare oneself for the real thing, but it really is not enough. And the reason for this is that there is nothing like the sinking feeling that you get when an investment goes poorly on you. Most humans are extremely loss-averse, meaning that they feel the pain of a 100 loss much more acutely than they feel the joy from a 100 gain. The emotional nature of investing has the power to force investors to do things that they would not do had they been objective observers with no skin in the game.
There are a number of ways that individuals react to losses. They may rush into poorly-thought-out investments in an attempt to quickly win back what they lost, making them take riskier decisions. Or, conversely, they may become paralysed with fear and be unable to pull the trigger on good opportunities.
Losses are an inevitable part of any investors journey but reacting badly to them doesnt have to be. Taking time off to cool down and objectively assess your performance after making a bad decision is often the best way to make sure that you dont make further mistakes.
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