Published May 07, 2012
Before you jump into the markets, take the time to learn from the missteps of novice investors. Here are three common first-time investing mistakes.
Not having a plan
A common mistake among first-time investors is that they lack a solid plan that will carry them through good and bad times, says Mark Holder, chief investment officer at Oklahoma-based portfolio management firm Stone Fox Capital Advisors.
"Following the herd tends to get [first-time investors] into the hot stock or mutual fund at the top," says Holder. "They'll end up panicking out of a stock during weakness because they don't understand the investment thesis."
No two investors are the same, says Carrie Schwab-Pomerantz, senior vice president at Charles Schwab, so you need to establish your own objectives and goals - like a house, kids' education, early retirement - before you invest. Also take into account your age and risk level.
Your plan should also include keeping up with the progress of your investments. "You do that by comparing your results with reliable industry benchmarks," says Schwab-Pomerantz. "Once you've done your comparisons, you may need to rebalance your investments to maintain the asset allocation that's right for you."
Ignoring asset allocation and not dividing your money among stocks, bonds and cash is another mistake, says Schwab-Pomerantz. New investors should build diversified portfolios, too, and not put their eggs in one basket, so to speak.
"Holding a mix of investments...will help you avoid excessive risk and help your portfolio grow," she says.
Failing to think long-term
Along with not having a clear plan for their investments, first-time investors often lack a long-term view for their investments, says Zack Shepard, an accredited investment fiduciary analyst and financial coach with Matson Money -- a Mason, Ohio-based investment advisory firm.
Shepard explains that new investors often chose funds based on past performance, limiting their focus to the short term and taking a gamble on what's hot. He says investors should ask the right questions. Instead of asking what stocks you should be buying, focus on how you are going to measure your portfolio's diversity.
"If you are going to gamble, go to Vegas, don't do it with your retirement," Shepard says.
New investors tend to trip up when they try to time the market, says Jon Ulin, a certified financial planner in Boca Raton, Fla.
"They buy emotionally on the way up and sell on the way down," Ulin says. "Markets are rational and efficient over time, investors are not."
Overlooking fees and taxes
Ulin says many investors purchase commissionable products, such as variable annuities, but really do not understand the fees, investment options and liquidity features up front.
Ulin advises new investors to focus on keeping their total investment and product expenses as low as possible. "If your total investment expenses are 3 percent and you are only returning 4 percent net of taxes on your portfolio, you may be better off investing in a 1 percent CD over time."
Ignoring the costs related to mutual funds and other investment options can be a setback, says Brent Lindell, an advisor with Rockford, Ill.-based wealth management firm Savant Capital Management. In the case of mutual funds, the cheapest quintile from 2005 in domestic equity returned an annualized 3.35 percent over the subsequent five years, according to data from Morningstar. Compare this to the 2.02 percent return for the most expensive quintile.
Schwab-Pomerantz adds that taxes can put a dent in your overall investment returns. However, a basic understanding of tax rates as well as taxable and tax-advantaged accounts can help you find ways to minimize the damage.