As the great investor Warren Buffett once quipped — investing is easy, but not simple.
You see, understanding the principles of investing isn’t tough, but putting it into action requires courage, fortitude and discipline.
Prudent investing involves purchasing shares of great companies and holding them over the long-term.
Dividends received should, ideally, be reinvested into the same strong companies to achieve a compounding effect.
By doing so, you can grow your nest egg significantly over the years and enjoy a comfortable and secure retirement .
However, as humans, we will probably not be able to avoid making mistakes along your investment journey. I have made my fair share of mistakes.
The key is to ensure such errors are small so that you do not blow a large hole in your investment portfolio.
We should also imbibe the learning points from each mistake to improve our investment process and to avoid repeating them.
Here are three mistakes you should avoid making.
1. Chasing share prices, buying into hypePHOTO: Unsplash
The stock market can feel like an emotional roller coaster when your money is at stake.
When a hot tip or piece of positive news on a company is circulated, it can cause a buying frenzy. As more and more people pile in, they end up chasing share prices ever higher.
Such emotion-driven behaviour can cause share prices to detach from the fundamentals of the underlying business. Valuations become too lofty and sentiment over-optimistic.
Additional hype could also be generated by brokerage firms that issue bullish reports to encourage more churn.
Buying the shares of such pumped-up companies could leave you with a scant margin of safety, and expose you to the risk of a sharp crash should sentiment turn.
Our advice is to avoid such reckless speculation as it could potentially burn a big hole in your wallet.
2. Over-tradingPHOTO: Unsplash
Share price volatility can have an unexpected effect on some investors.
By observing the frequent swings in the share price, coupled with sentiment-driven news flow, some investors may come to believe that they can successfully time the market and achieve consistent capital gains.
Armed with this confidence, these investors end up racking up huge trading commissions when they execute multiple trades within a short period of time.
The problem here is that no one has been known to time the market perfectly.
For the average investor, each buy and sell transaction should see a fair share of profits that are balanced by losses.
The downside of such behaviour is that you end up paying significant amounts of commission to your broker, while also having to endure the stress associated with trying to time your entry in and out of the market.
Excessive trading is a big mistake that you should avoid as it ends up eroding your wealth over time.
3. Holding on to losersPHOTO: Unsplash
None of us can claim to have a perfect track record when it comes to picking stocks. Even with our best efforts, some companies may turn out to be lemons.
Ask any investor out there, and there is a good chance they own a bunch of poorly-performing stocks.
Don’t get me wrong though – there is nothing odd about having bad investments.
After all, the world is unpredictable, businesses and industries can change and evolve in unexpected ways, what more when you have major incidents such as the current Covid-19 pandemic brings companies to their knees.
But it’s how we react to bad investments that determine our investment performance.
If you insist on doggedly holding on to a poor investment, then these lemons will end up losing money for you over months, if not years.
Retaining losers within your portfolio ends up being a double sin.
Not only do they erode your capital base over time as they continue to do badly, but they also represent an opportunity cost as this capital could have been better deployed in promising companies that can go on to compound your wealth.
My advice would be to periodically do a “spring-cleaning” of your portfolio.
Identify the duds within and consider selling them or at least trimming your position in them, while deploying the freed-up capital to more promising investment candidates.
This article was first published in The Smart Investor.