Over the long haul, the stock market tends to make most participants very wealthy. Very few people reach retirement without the help of the stock market to compound their wealth along the way.
While the stock market makes many people rich, it also makes many people poorer. If the long-term trend is up, everyone who participates should see their wealth grow, but some people end up lagging the market by making a few common errors.
Common Mistakes to Avoid
- Managing your money before you’re ready – Investors who are new to the concept of the stock market would be wise to start first with broad market exchange-traded funds or index funds. Buying into an index fund lets you grab onto the powerful compounding power of a long-term investment in the stock market without interjecting your own inexperience into the results. If everyone could jump in and beat the market from day one, everyone would be doing it.
- Failing to do the due diligence – Managing your own money takes time and effort. Anyone who manages their own money will need to dedicate a substantial amount of time to following their investments. Individual stocks require the most time. Companies file quarterly reports three times per year (10-Q reports), annual reports every year (10-Ks), while releasing a myriad of other important releases (8-Ks) each year. To give an example of the amount of information an investor has to consume, Exxon Mobil’s annual report from 2011 was 111 pages. The quarterly reports were roughly 30 pages each – and we’re only talking about one stock.
- Making trends of things that don’t exist – During the dot com bubble of the late 1990s, one fund manager declared that he expected to make 40% per year for his investors for the next 10 years. Keep in mind that this person was college educated in finance, had the credentials to manage billions of dollars, yet still fell for the “get rich quick” mindset that internet stocks would go up by nearly 5 times the historical average for a decade straight. When the market or your individual stocks are going up, it’s easy to project that undeserved bullishness into the future, often to be disappointed with the results.
- Ignoring the role of time – Time plays an important part in deciding how you allocate your investment capital. While stocks have historically returned roughly 8% per year, their best years have been much higher performing and their worst years much worse than 8%. You should only invest funds in stocks if you see no need for the money for the next decade. Invest in bonds only if you won’t need the money within the next few years. And if you need the money for a short-term use, then keep it in cash or CDs. Don’t put your down payment on a dream home in your brokerage account!
Avoid Mistakes to Improve Performance
The best investors are the people who avoid making mistakes. Having some self-awareness helps a lot here; if you are not interested in watching the markets religiously, stick to index funds or hiring mutual fund managers. If you are up for the challenge and have an interested in all things accounting and finance, managing your own money – after doing complete due diligence (see article on how to pick a stock) – may be right for you.