The Biggest Mistakes First Time Investors Make
09 01 2016
There is no two ways about it; everyone has to start from the beginning. You need to learn to walk before you run. This is just an example amongst numerous other idiomatic expressions that speak of the need to master a basic skill before you are able to get good enough to learn more complex processes. Learning the basics before achieving mastery is true in every facet of life and becoming a financial investor is no exception.
Now, it’s true that when it comes to investing, the ‘beginning’ point is different for everyone, or rather the size and scale of an investment is different for each person. Some take their first step into investing when they decide to place a percentage of their salary into a work sponsored 401K plan. Others, with larger levels of expendable income, make their bones as an investor by placing their money directly into the stock market or an alternative investment option such as commercial real estate, private equity, and venture capital. As a first-time investor you may find yourself at any given point of this spectrum.
That being said, these are the four biggest mistakes new investors often make. Hopefully, by taking these mistakes into consideration and with a little foresight, you can avoid these common pitfalls of the investment learning process.
4 Biggest Mistakes By First-Time Investors
- Failing to research and
understand an investment
An investment can be anything that requires you to risk your available capital for the opportunity of having it grow into more than what you started with. However, the level of risk you assume is different for each type of investment. Moreover, your risk factors can be exponentially greater if you are not knowledgeable about what you are placing your money into.
This seems like a simple enough thing to do. Yet, many investors fail to do more than light research on where they are placing their money. In fact, too often investors place blind faith and their money with what they heard on TV, their financial advisor, friends and family, who all claim to know about an investment, without really understanding where their money is going.
Thanks to the advent of the internet, there is not much of anything that cannot be found and researched online. It would behoove any person looking to invest their money into an investment to perform in-depth research. When it comes to researching an investment, it’s a good rule of thumb to heed the words of Albert Einstein, “If you can’t explain it simply, you don’t understand it well enough”.
- Underestimating risk
“With great risks, come great rewards”. Unfortunately, for some new investors, the first part of Thomas Jefferson’s quote can fall on deaf ear. This, of course, is not intentional. When the possibility of larger returns and benefits are present, it can be hard to remember the potential pitfalls of an investment. One need only turn back the clock a few years, to before the last real estate market crash, to see the effects of miscalculated risks. Many would-be homeowners and beginner real estate investors threw caution to the wind, as they purchased real estate using option-arm, no-income, and no-job verification loan programs. By only making payments at the lowest level under this program, their mortgage debt grew. Furthermore, many investors did not fully consider their ability to pay their mortgage back should their loan reset with a larger balance along with a higher interest rate. Many real estate investors purchased their primary residence and even non-owner occupied investment real estate using this mortgage strategy.
As long as rates stayed low, as long as property values continued to rise, and as long as there were loose financing options, these negatives were masked by positive financial benefits. For a while, many first time investors who participated in that historic real estate cycle could do no wrong. In fact, at the time, not participating in the real estate investment fervor seemed like the risker financial decision. The problem was real estate markets have cycles, financial environments change, and the risks were real. Investors need to be ever cognizant of the level of risk an investment has and make their decisions accordingly.
- Putting all of your eggs in one
Great investment opportunities can be few-and-far-between. No one wants to feel like they missed the boat or did not take full advantage of a promising investment. Unfortunately, shortsightedness leads some first-time investors to get overcommitted to an investment or investment strategy.
As previously mentioned, financial environments change. Both riskier investments as well as conservative investments can prove to be smart and/or foolish, depending on where on the investment cycle an investor happens to be.
A new investor needs to weight their desire for larger short-term success against long-term gains. By not putting all of their eggs in one basket, an investor can create a diversified investment portfolio, which will allow them to balance the effects of investment highs and lows from multiple industries and markets. Experienced investors have chosen to increase their portfolio diversity with the addition of alternative investments that have a low correlation to stocks and bonds.
- Mistaking “beginners
luck” for mastery
No one wants to fail and lose money in the process. But failure can often provide us with knowledge and experience we would not have otherwise received. It does so by challenging us to seek other avenues of knowledge and view situations from different perspectives in order to solve a problem. Through this process we develop mastery.
Bill Gates, founder of Microsoft, once said, “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” Being able to grow wealth through investments is great! But earning money fast through investments, without experiencing setbacks, has led some first-time investors to overestimate their mastery of an investment. In the long run, the hubris created by instant success can prove to be a larger liability to an investor, as well as a deterrent to personal and financial growth, than having had experienced some financial set-back.
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