I've been investing since 1996. In the process, I have learned a lot, mainly from trial and error. I'd like to share my experience with you. Here are some of the mistakes I've made:
- Not investing soon enough — I have been working part-time since my first year at college in 1991. If I had known what I know today, I would have invested my money in an IRA from day one. But like many other young adults, I was thrilled to have money and to spend it all on things that I enjoyed — movies, games, electronics, etc. If I had invested just $2,000 per year while I was in college, that $8,000 invested in an S&P 500 index fund would be worth about $36,000 today.
- Not knowing the basics— When I finally began investing, my first move was to give my money to a full brokerage firm to invest for me. I didn't know anything about stocks or mutual funds. I just knew I should invest money to make more money. This was a big mistake since each trade executed by my broker cost a lot of money. Also, the mutual funds they picked weren't good, and were very expensive.
- Chasing past performance — Once I got smart enough to switch to a discount broker, I committed another mistake. I chose mutual funds based on their past performance and Morningstar rating. I picked several loaded / high expense-ratio funds that lagged the general market in the subsequent years.
- Experimenting with my IRA — Back then I had tons of ideas. Unfortunately most of my money was in IRA, so I experimented using my retirement money — big mistake! First, money lost in an IRA cannot be replenished. I was allowed to deposit $2,000 per year and that was the limit. Second, I could not claim my losses as tax deductions. Since the IRA was tax-sheltered, the loss was simply a loss. [Learn more about IRAs.]
- Not paying attention to expense ratios — Not until recently did I realize how badly expense ratios can affect investment performance. I always thought “it's only 1%, what's the difference,” and went for the investment with better performance. I finally ran some numbers and I was shocked to learn that a difference of 1% can lower my investment performance by 25% over the course of 30 years. Instead of ending up with $1 million, for example, I might only have $750,000.
- Not paying attention to distributions — This is another number that I did not pay attention to back then. I held some funds in my IRA and some in my regular account. For a couple years, I thought high distribution was really cool because I was making more money. How silly was that? Now I realize that I am paying other people's taxes when I get mutual fund distributions. Now with my regular account, I invest either in low distribution funds or in ETFs. (Distributions do not affect IRAs.)
- Not paying attention to asset allocation — Way back when, my investment was mainly in large-capitalization U.S. stocks and funds. I did not know about asset allocation as a risk management and performance enhancement tool. It wasn't until 1999 — when I became eligible for a 401k — that I started giving asset allocation serious thought.
- Ignoring diversification — Again, with little experience and little money to invest, I was going after high-flying stocks (at least I thought they were) and did not pay any attention to diversification. Like asset allocation, it took me a long time to realize how diversification helps to reduce risk and enhance performance. The value of diversification became apparent to me at about the same time that asset allocation did.
- Selling winners and keeping losers — This was my all time weakness. I knew the concept of “buy low and sell high.” So with little experience, I ended up selling a lot of my winners like Staples (SPLS), Ameritrade (AMTD), and Microsoft (MSFT) to lock in the gain; but held on to my losers like Flemings (FLMIQ) and eToys (ETYS).
- Cost averaging down — This was another “buy low and sell high” mistake. Not only did I hold on to my losers, I bought more shares in hope of lowering my cost basis and reducing my losses. I did this blindly without additional research to find out why these losing stocks went south.
- Investing without a goal — Not until recently did I define a real goal for my investment — among other things, one of my investment goals today is to build a $1 million investment portfolio by 2017. This is my main retirement portfolio. Other goals, which I am still defining, are investing to subsidize my kids' college expenses and my parent's retirement expenses. Without a clear goal, I was chasing short-term performance and was prone to act on market swings.
- Selling on corrections & buying at the top of the market — These are symptoms of not having a clear goal. Since I was chasing short-term performance with the objective of making more money. I occasionally gave in to my emotion and sold my investments during corrections to protect my gains. Occasionally, I did come out ahead, but most of the time I ended up rushing to reinvest my money as the market invariably rose after these corrections.
As you can see, I was not a very good investor, and it took me a long time and too much money to learn from my mistakes. I hope that by sharing these common pitfalls, you can avoid some of them on your journey. Good luck with your investing!