When I started investing after a windfall, I made a bunch of mistakes. Trying to navigate the investing landscape is daunting for a first-time investor, and I was no different. In the 12 years since I started investing, I’ve learned a lot about how to build wealth. I’ve realized that the same mistakes I made are all-too-common. Here are some of the most common mistakes that I’ve seen by first-time investors, myself included.
1. Not Investing
If you’re new to investing, it’s hard to get started. Everyone is looking to make money off you. If you’re looking for a way to get started today, I have a free course on how to invest. I write a bunch here on how to invest. I talk on Slack about how to invest. I want you to invest not because it’ll make me in money, but because it’s the best way I know of to assure you’ll be financially independent someday.
If you’re absolutely new to investing, I’d recommend one of a few routes:
- Go through my free Minimal Investor Course. It’ll teach you the basics of investing for you to feel confident and invest for the rest of your life.
- Throw all your money in a target retirement date fund at your brokerage if it has a fee under 0.25% (ex: Vanguard Target Retirement 2050 Fund). If you’re just starting today, these aren’t a bad way to begin.
- If you want to research a little bit more, learn about how to use a 3-fund portfolio.
- If you don’t want to invest yourself, and just want to pay someone else to do it, I recommend Wealthfront.
2. Checking Your Investments Too Often
One you deposit funds into your account, the best thing you can do is forget about them. Just let them to grow! Constantly checking them isn’t going to help. If the market has a bad day or a bad month, how does that impact you? If you’re investing for retirement, then you don’t need those funds today.
Keep your eye on the long-game and don’t get distracted by market fluctuations. I check my own investments using Personal Capital every 3 months and write about them in my quarterly investment reports.
3. Not Diversifying Your Investments
I recently saw a post in /r/CryptoCurrency on Reddit about someone who “diversified” their investments by investing in a bunch of different cryptocurrencies. They haven’t had the greatest month:
Diversification doesn’t mean investing in a bunch of different things! If you’re investing in a number of investments that are highly correlated, you’re not diversified.
Diversification means investing proportionately into unrelated asset classes that aren’t strongly correlated.
The main example of something that isn’t correlated is stocks and bonds. It’s common to see one go down the same day the other is going up. If your portfolio is diversified, you’ll experience fewer fluctuations. Look at the following chart of US stocks vs bonds over the last decade. Bonds have slow and steady growth, while the US market is all over the map.
If your portfolio consisted of [your age in bonds] plus the rest in stocks, then your portfolio would be a line that’s neither as bumpy as the US market, or as a straight as the bonds line.
A well-diversified portfolio should have exposure to at least 2, but better yet 3 different funds asset classes (US Stocks, International Stocks, Bonds). In each of those asset classes, you should be highly diversified into thousands of different investments. Luckily, you can do this all with 3 funds! There are a lot of strategies for diversifying, and this is just one example.
4. Thinking an Investment Advisor will Provide the Best Returns
No one can promise the best returns. Not me, not a financial advisor, not Warren Buffett. There’s only the all-to-familiar statement:
Past performance is no guarantee of future performance.
I got sucked into this one and ended up paying more than 2% in management fees and expense ratio fees because I thought they could do things much better than I could. At the time they could! But very quickly it became clear what they were doing was something I could do on my own. A 2.5% fee will consume 44% of your total earnings over 30 years (assuming 7% average growth).
5. Going All-in on Speculation, Day-Trading, Pump & Dump, or any Get Rich Quick Idea
I’m going to level with you here – if there’s anything that could make you rich fast, you probably shouldn’t invest in it. It’s the same idea with lottery tickets, just on a smaller scale. If you want to get rich quick, you’re not investing, you’re gambling. The real ways to build wealth aren’t the sexy cryptocurrency of the week or the hot stock that just IPO’d. The real way is much slower but has the highest chance of success.
6. Not Automating Your Investments
Investing on a schedule (each paycheck or each month) helps your budget get used to putting money away somewhere else. If you’re doing this entirely manually, it’s much more likely you’ll miss a deposit. Instead, set up a repeating deposit at your brokerage and just forget about it. Increase your 401k contribution to the max. Automatically deposit into your Roth IRA or IRA. Make it automatic.
At Vanguard, this repeating deposit is free! If you have a 401k, IRA or are investing in mutual funds/ETFs through the offering brokerage then they’ll almost certainly be free to invest each month as well.
7. Trying to Time the Market
If you look at the US stock market for any year in history there’s a good chance it will have had an all-time high that year. If you’re trying to wait until there’s a crash to invest, it’s much more likely that you’ll miss on investment gains, than that you’ll pick just the right time and buy. This is so common that there’s an investment mantra about it:
It’s time in the market, not market timing.
You won’t know when things have reached their all-time high, just like you won’t know things have reached their all-time low. The more time you can be invested in the market, the more likely you are to benefit from the gains.
This means that mathematically speaking, even if you receive a large windfall the correct choice of action is to put it into the market ASAP. This can be daunting. If it helps you sleep at night, consider dollar cost averaging it into the market – depositing 1/12 of it each month over the next year.
8. Not Considering Fees
Fees are a silent killer for gains in many portfolios. There are a bunch of different fees that are common in the investing world, but the 2 big ones are expense ratio fees and investment advisor fees. Expense Ratio fees are fees tied to a specific investment. For example, the Vanguard Total Bond Market Fund charges a fee of 0.05%. That fee is yearly, so if you have $10,000 invested, about $5/year will go to that fee. You won’t ever see that fee – it’ll be included in the share price of the fund. A “good” fee to me is anything under about 0.15%, but the lower the better!
An investment advisor fee is charged by your advisor (either Betterment, Wealthfront, or a real person) for managing your investments. These fees can range from 0.25% for robo-advisors up to over 1% for a real person you can call and talk to. Just know that on the high end you’re paying a lot for their service.
The big difference between these two is how YOU get the actual bill for them. With investment advisors, you’ll usually have a small “cash” portion of your account. Every quarter or so, you’ll see a payment from your cash account. This is paying the investment advisor fee.
With expense ratio fees it’s much different. You never pay them yourself from a cash account. Instead, the fees are factored into the funds’ actual price. If there were two funds that invested in the exact same things, but one had a 0% fee, and the other had a 1% fee, then the value after a year would be higher for the fund with a 0% fee.
I think of these fee as being out of 7% (a number I use to represent my yearly market gains) rather than out of 100%. For example, if you’re using an investment advisor who charges a 1% fee, and they choose some funds that have a 1% expense ratio fee, that’s 2% out of your potential 7% in gains each year going to fees. That’s almost 30% of your potential yearly growth going to fees! In order to make it up, your advisor/fund combo will have to do 30% better than an index fund just to do as good.
9. Selling too Often
If you have investments in a brokerage account (a taxable account), then every time you sell funds is a taxable event. If you have investment gains (short-term or long-term) you’ll end up paying taxes on them at the end of the year.
That’ll be your responsibility to pay taxes on. If you’re investing with a financial advisor, they might not have any idea of your tax situation, and may make decisions to buy/sell based on the market without thinking about taxes at all! If you don’t sell, or sell less, you don’t have to worry about capital gains taxes.
Buying and selling funds in a tax-deferred account is great! Do it as much as you want. It’s a good way to learn how to invest. It’s a good way to practice choosing funds you want to hold long-term.
10. Not Planning Taxes
Taxes come in a number of different forms. One is the yearly taxes you get if you sell funds for a gain in a taxable account.
Another huge one is understanding which investments make sense in which investment account. This relates back to the principles of tax-efficient fund placement, which is a bit of a can of worms. If you have 1 account, you don’t need to worry much. Just diversify it. If it’s a brokerage account, maybe see if there’s a tax-optimized version of a bond fund. If you have multiple accounts, here are a few key points to think about:
- If you can, hold bonds or other funds with a high yield, dividend or turnover in a 401k or a traditional IRA. (this will save you paying taxes every year on the dividends)
- If you have funds that are high growth with a low yield, hold them in a taxable account. (US Market Index funds are an example of this).
- If you have a Roth IRA, you could hold more bonds there, then anything else that might grow with a yield. I have a REIT (real-estate investment fund) in my Roth.
I recommend choosing your own asset allocation, then finding out the best way to distribute it over all of your accounts to minimize taxes.
11. Always Trying to Optimize
There will always be a fund that is doing better than some of the funds you’re in. One of the things I did a lot when I was starting to invest was thinking that by making changes I was in control. That’s just not true. When you’re investing, you’re at the mercy of the markets. You can diversify, optimize for taxes, and make all of the right decisions, but things can still go down. Or you could see other people’s portfolios increasing much faster than yours. This will always be the case. If you can find a way to be happy and confident in what you’re invested in that’ll be a huge help.
When I was starting investing one thing I did was to post on the Bogleheads forum, a community of investors, asking for a review of my portfolio (see the format here). I laid out all of my accounts, the values of each and asked for feedback. Doing this even before making investments is a great option too – as you can get feedback from others that are passionate about investing for free. I remember some of the feedback I got was to max out my 401k – something that mid-20s Adam wasn’t doing. Find what works for you.
What mistakes have you made when investing? What mistakes do you think are common?
2 CommentsWhy not add to the conversation below? Your voice is welcome!
April 16, 2018
Hi Adam !
I am looking closely at my 401k investments and they have 25% of them in RWIGX with expense ratio of 0.45 % and other holdings are a bunch of variable annuities with similar fees.
Now I have started educating myself recently and have learnt till now that low fees is better, but I wanted to know what are the scenarios when a fund like this (with high fees) is better.
I asked my advisor at TIAA , who manages these funds and she told me that these were selected based on my risk tolerance ( that showed me to be a VERY AGGRESSIVE investor)
Secondly, what the hell are variable annuities and do they have any place in retirement accounts ?
April 17, 2018
When it’s still lower than the other alternatives! Saving in a 401k is almost always worth it, so it sounds like if that 0.45% fund is your best bet, it’s still better than paying taxes on that money then investing it.