Most investors – if not all – are sometimes mistaken. Fortunately, one can learn from one’s mistakes and even others’. Here are ten examples of common mistakes and tips to avoid them.
The first thing about investing is to check if the person and the company offering the investment can sell it to you.
Modeling your investment decisions on those of the neighbor
Remember that an investment that suits one person will not necessarily be right for you. Modeling your investment decisions on those of the neighbor seems like a simple mistake to avoid. Here is an example of a situation that could risk influencing your investment choices. Each investor has its objectives, level of risk tolerance, and investment horizon. If you have a written investment policy that applies to all of your investments, it will help you avoid investing in investments that do not meet your investor profile.
Invest in an investment you do not know or do not understand
Here are some examples that may lead to investing in investments that we do not understand.
- Investing simply because a financial analyst recommends the purchase
- We have heard about society in the media, and it seems a good idea to invest.
- Our representative offers us this investment. We trust it without thinking and without asking questions to understand the investment.
If you do not understand the investment that is offered to you, it is better to refine your financial knowledge first. One of your investor responsibilities is understanding the investment in which you invest. This includes understanding liquidity, performance, risk, and fees.
Buy based on information without having verified it
Never invest in investment without informing yourself. All information posted on the Internet is not accurate. For example, if a person predicts that the value of an investment will increase, this will not necessarily be the case. If it is a share of a company, it may be important to know what are the expected profits of that company.
Disregard his risk tolerance
When a representative asks you questions about your risk tolerance, answer as honestly as possible. For example, if you can not stand the value of your investments fluctuating, say so.
Do not admit mistakes
Some investors do not want to sell an investment at a loss, even if the future prospects of this investment deteriorate considerably, simply because they would admit they made a mistake.
Some investors even buy more of the same investment to lower their average acquisition cost. This strategy can sometimes work, but only if the value of the investment rises enough. If the value of the investment continues to fall, the loss will be more significant.
To help you avoid this error, you may want to specify limitations in your investment policy, such as not investing more than a certain percentage of your portfolio in a corporation.
Do not confuse this error with not selling your investments when the stock market goes down.
Falling in love with a stock market
An investment you have had for a long time and has yielded a significant return has been steadily losing value for some time. Recent financial news does not seem positive about the future of business. Assuming it will revalue over time, you buy it back many times, even if it hurts the diversification of your portfolio.
It is risky to “fall in love” with a stock market and lose all objectivity. It is equally important to remember that a stock’s past performance never guarantees its future performance.
When you invest, put aside your emotions and set limits based on your risk tolerance and especially your investment horizon. Do not forget the principles of portfolio diversification.
Adopt confirmation bias
This error consists of listening only to the tips and information that corroborate what you already think. For example, you believe that a title will gain value. Remember all the positives that support your hypothesis, for instance, that the company operates in a promising sector and has little debt.
On the other hand, you are not interested in anything that might affect the future value of the security, for example, whether a major new entrant enters the industry or the company does not clear profits.
Adopt a bias of optimism
This bias consists of thinking of oneself better than one is and seeing the future more positively than reality. This bias can be detrimental to investors, such as investing in seeing only potential earnings and forgetting the risks.
One way to reduce the errors caused by this bias is to ask yourself what is the worst loss you could incur by investing in the targeted investment. To do this, look at the stock market fluctuations of the security. This fluctuation could happen again, even if the past is not a guarantor of the future.
Perform a naive diversification
Naive diversification is meant to equitably distribute its money among all products offered, regardless of whether these products are similar or different. For example, if the representative offers us four equity funds and one bond fund, we invest one-fifth in each fund.
Adopt an employer bias
This mistake consists of investing an inordinate proportion of a company’s assets simply because “it is a good company.” Even if the idea of investing in a known sector is good, it should not hurt the basic principles of investment, such as diversification. Worse: If the company you are working for is in financial difficulty, you could lose both your job and see the value of your securities drop considerably.
One way to limit the consequences of certain behavioral biases is to invest money in a diversified portfolio periodically.
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