Two common investing mistakes to avoid

We all make mistakes. Even the greatest, most experienced investors get it wrong from time-to-time. But making costly mistakes when managing your risk could put your financial goals on the rocks.

To help you get ahead, we take a look at what investors can learn from two common investing mistakes.

This article gives you information to help choose the right level of risk for you. But it’s not personal advice. If you’re not sure what’s right for your circumstances, we have experienced financial advisers who can help.

It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes

Warren Buffett

#1 - Be an investor, not a speculator

It’s important to never confuse a speculator and an investor – they’re very different.

A speculator doesn’t really care what they buy and their time horizon is usually very short. All they hope is that it’ll be worth more tomorrow than it is today. We think being a speculator is very risky. Trying to anticipate which way prices will move in the short-term is the same as guessing whether red or black will come up on a roulette wheel.

If you buy an asset in the hope you can sell it for a higher price tomorrow you’re gambling. Don’t mistake this for investing – it isn’t. You might think there’s nothing wrong with doing this, so long as you’re betting money you’re prepared to lose.

In comparison, an investor gives their money to a business – either directly through buying shares or indirectly through a fund or investment trust. They do this in the hope the company will use it to grow and generate a profit. That profit can be paid back to investors as a dividend or reinvested in the business to fund future growth.

Either way, an investor expects to have their money tied up in the business for some time. What the price is tomorrow doesn’t matter to them, since they don’t expect to cash their money out in the short term. Over the long run, the volatility can be smoothed out.

I don’t know if a coin will be heads or tails on the next flip, and if I bet on any outcome, I have a 50% chance of losing my money. But over the long term I know it will be heads about 50% of the time and tails about 50% of the time. Investing takes this kind of long-term view.

Thinking long term with your investment strategy and avoiding short-term noise is the better way to secure a better financial future.

#2 - Don’t follow the herd

Herd mentality is a behaviour where people act in the same way or copy the actions of others around them – often putting aside their own feelings in the process.

Let’s say you’re given the choice between eating out at a busy restaurant or an empty one, which one would you choose?

Most of us would walk straight into the busy restaurant. Mainly because British people love to queue, but it’s also human instinct to mirror other people’s actions. We take comfort from knowing we’ve acted in the same way as someone else – that’s herd mentality.

What about if I chose the empty restaurant? For the small minority that opted to not follow the crowd, they’d likely suffer from the ‘fear of missing out’ or FOMO.

We see examples of herd mentality and FOMO in the investing world too.

It’s common for investors to gravitate towards fashionable stocks. Not because they’re the best investment opportunities, but because that’s what the masses are buying. It’s the fear of missing out on profits that others could be making.

One of the most clear-cut investing examples of herd behaviour is the dot-com bubble (also known as the internet bubble). In the late 90s and early 2000s, lots of investors flocked together to pump billions into small technology-based companies in an attempt to cash in on the internet boom.

Dot-com bubble - NASDAQ Composite

Past performance isn’t a guide to future returns. Source: Lipper IM, to 31 December 2002.

But much like blowing up a piece of bubble gum as a kid – as more and more investors piled into the tech market – the bubble eventually burst.

The internet start-up stocks didn’t live up to their hype and investors lost patience. The tech-heavy US index, the NASDAQ Composite rose and fell by over 200% between 1997 and 2002 – surrendering all its gains made during the bubble.

Following the herd and making investment decisions based on what others are doing is rarely a recipe for success. You shouldn’t feel pressured to invest into high-risk assets, like cryptocurrencies, just because you see others doing it. Remember, investments should be a long-term thing, not a get-rich-quick scheme.

That’s not to say if you believe in the long-term prospects of an investment which coincidentally happens to be popular at the moment, you shouldn’t invest. Popularity alone shouldn’t be a reason to steer clear.

But it’s important for investors to see the full picture and stay diversified. Investing your money across a wide range of investment types, sectors and geographies reduces the overall impact to your portfolio if things take a turn in one area.

Diversification – starting to think strategically

Looking to spread your risk more wisely?

Our investment research team have put together some investment ideas to help you get started, but they’re not a personal recommendation to buy.

Mixed investment funds can be a great way to spread money across lots of shares and bonds – helping achieve greater returns with a relatively-lower level of risk.

For investors prepared to accept more risk, small and mid-sized companies funds can offer you an adventurous, but higher risk, way to grow your wealth.

Investing in funds isn’t right for everyone. Before investing it’s important to check the fund’s objectives align with your own, understand the fund’s specific risks and if there’s a gap in your portfolio for that type of investment.

Remember, funds go down as well as up in value, so you could still get back less than you put in.