3 Top Investing Mistakes -- and How to Avoid Them

By Markets Fool.com


Image source: Getty Images.

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It's hard to become a successful, increasingly wealthy investor without making blunders along the way -- ones that will cost you some, or many, of your hard-earned dollars. Fortunately, you can avoid many financial errors by learning from the errors of others, and by reading up on investing.

Here, then, are three top investing mistakes that many people make. Once you're aware of them, you may be able to avoid them, saving yourself heartache and financial loss.

1. Cutting the flowers and watering the weeds

:One common mistake that many investors make is selling their winners early, while at the same time doubling down on their losers. Famed investor Peter Lynch described this behavior as "cutting the flowers and watering the weeds."

Following this strategy will almost certainly cost you a bundle in the long run -- because winning companies tend to keep on winning, and losers tend to keep on losing. Being in a rush to lock in gains on your winners is a quick way to ensure that your portfolio is stuffed with losing stocks -- and that you miss out on the future growth of those winners.

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I've personally made this mistake many times, and it has cost me a bundle. In 2011, I was up big on my position in Under Armour, and I thought that its "expensive" valuation made it a good selling candidate.Take a look at what has happened since I parted ways with my shares.


UA data by YCharts.

Lesson learned. Winners tend to keep on winning. Hold on to them tight. (Of course, keep up with them regularly, too, to make sure they're still on track, and not developing any problems.)

Warren Buffett has long advocated that investors should hang on to their top performers. Here's a choice quote from his 1998 annual letter to shareholders:

When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well, but who tenaciously hang on to businesses that disappoint.

I've since had this lesson seared so deeply into my brain that I've been extremely reluctant to part ways with any of my winners. I'd be willing to bet that this strategy change will pay off hugely for me in the long run.

Image source: Getty Images.

2. Underestimating the power of tax advantages

: One mistake investors should avoid is keeping stocks, especially those that pay dividends, in a regular brokerage account, instead of taking advantage of tax-advantaged options. While many people are familiar with retirement accounts such as 401(k)s and traditional and Roth IRAs, you may be surprised at just how much of a difference it can make over the long run.

Let's say that you invest $5,000 in stocks in a Roth IRA when you're 25, and that these stocks pay an average dividend of 3% per year. If the share prices rise at a 6% annualized rate (9% total return), this investment could grow to more than $144,000 by the time you're 65. And as long as you're 59-1/2 or older, you can withdraw your money without paying any income tax.

On the other hand, let's say you make the same investments in a taxable brokerage account. Assuming a 15% dividend tax rate, this drags your 9% total return down to 8.55%, resulting in a $122,600 nest egg, instead more than $21,000 less. What's more, this amount will be taxable. Even if you're in a low tax bracket, say 15%, in retirement, this amount drops to about $104,200, nearly $40,000 less than if you had made the exact same investments in a tax-advantaged account.

The point is that you shouldn't underestimate the long-term power of tax-free or tax-deferred investing. It can seem inconvenient to have your money tied up until you reach retirement age, but as you can see, it's worth it.

Image source: Flickr user David J. LaPorte.

3.Ignoring boring companies

Selena Maranjian: A common investing mistake is to bypass lots of terrific -- but boring -- companies, looking for exciting high-flyers. It's natural to be drawn to businesses that capture your imagination, but it can hurt your portfolio if you're ignoring boring companies.

A dynamic, fast-growing company may generate massive profits for you, but it may also flame out. Such companies often need to invest a lot in furthering their growth, and while some simply run out of money, others have to take on costly debt, or issue more stock, diluting the value of existing shares. Sarepta Therapeutics, for example, a biotech concern developing a Duchenne muscular dystrophy treatment, has seen its share count roughly double over the past five years.

Even the more reliable and established fast growers, such as Amazon.com, have downsides. For example, they can often be overvalued, as everyone wanting a piece of them drives up their prices. There are great exciting stocks, of course, and poorly performing boring ones, but the table below should remind you that boring stocks can serve you quite well -- because they can grow briskly, too:

Stock

Business

10-year Avg. Annual Return

20-year Avg. Annual Return

Waste Management

Garbage

10.6%

6.5%

Kimberly-Clark

Consumer goods

12.9%

10%

Costco

Discount retail

13.2%

15.9%

Home Depot

Home improvement

17.1%

14.6%

Public Storage

Storage facilities

16.1%

17.5%

Sherwin-Williams

Paint

22.3%

15.8%

S&P 500

5.2%

6%

Another benefit of boring companies is that they often pay dividends. Fast-growing companies need all their excess capital to fuel their growth, but established, predictable companies often have more money than they can invest, so they'll reward shareholders directly with some of it. Stocking your portfolio with healthy and growing dividend payers is a great recipe for investing success.

The article 3 Top Investing Mistakes -- and How to Avoid Them originally appeared on Fool.com.

Brian Feroldi owns shares of Amazon.com, Under Armour (A Shares), and Under Armour (C Shares). Matthew Frankel has no position in any stocks mentioned. Selena Maranjian owns shares of Amazon.com and Costco Wholesale. The Motley Fool owns shares of and recommends Amazon.com, Costco Wholesale, and Under Armour (A Shares). The Motley Fool owns shares of Under Armour (C Shares) and Waste Management. The Motley Fool recommends Home Depot, Kimberly-Clark, and Sherwin-Williams. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.