Common Mistakes Made by Investors and How to Avoid Them – Part 2

In this two-part series, we are unpacking common mistakes investors tend to make as well as possible solutions to overcome them. In last week’s article, we discussed a few common mistakes made by investors such as how a lack of strategy can often result in overtrading, or how making emotional decisions and ignoring fees and expenses can harm your financial wellbeing in the long run. This week, we delve deeper into the topic, providing you, as an investor, with a clearer understanding of the potential pitfalls you can proactively manage and avoid.

Chasing past performance

Investors often look at recent high-performing assets or funds and assume they will continue to perform well. However, past performance is not a reliable indicator of future results.

Solution: When considering investments, focus on fundamentals rather than recent performance. Research the underlying assets, industry trends, and long-term growth prospects. A balanced approach often yields better results than chasing returns.

Not considering tax implications

Tax implications are frequently overlooked in investment decisions. Selling investments can trigger capital gains taxes, while certain accounts like retirement funds, or tax-free savings accounts have tax benefits. Failing to consider the impact of these taxes can have on your portfolio will ultimately reduce the real returns of an investment.

Solution: Understand the tax implications of each investment and take advantage of tax-advantaged accounts, like retirement products, where applicable. A financial advisor can also help create a tax-efficient investment strategy so it may be worth your time to reach out to one.

Lack of patience

Many investors lack the patience to allow their investments to grow over time. Remember that investing is a long-term journey, and expecting quick gains can lead to impulsive actions and poor decisions.

Solution: Remember that most investments require time to appreciate in value, therefore set realistic expectations and avoid comparing yourself to others.

Not setting a clear exit strategy

Many investors are so focused on getting into an investment that they overlook when and how they will exit. Without an exit strategy, investors may hold on to an asset longer than they should, or sell prematurely, missing out on gains.

Solution: Establish clear exit criteria before you invest. Decide whether you will exit when the asset reaches a certain price, or after holding it for a specific period. This approach helps you make more rational decisions instead of being driven by emotions or market noise.

Overlooking the power of compounding

Some investors make the mistake of constantly withdrawing gains from their investments instead of reinvesting them. This reduces the power of compounding, which can significantly grow wealth over time by reinvesting earnings to generate even more earnings.

Solution: Reinvest dividends, interest, and capital gains where possible as compound growth can make a significant difference over the long term. Even small, regular contributions can grow substantially when combined with compound interest.

Underestimating the importance of emergency funds

Investors often put all their savings into the market without setting aside an emergency fund. This can lead to financial strain or the need to liquidate investments at inopportune times if an unexpected expense arises.

Solution: Before investing, build an emergency fund that covers at least three to six months of living expenses. This fund provides a safety net and ensures you don’t have to sell investments when the market is down to cover unforeseen costs. An emergency fund should be easily accessible and liquid. Often a savings account with your bank can be used to ringfence this savings pot.

Failing to educate themselves continuously

The financial markets are constantly evolving, and an approach that works in one economic climate may not work in another. Investors who don’t keep learning or adapting to changing market conditions may miss out on new opportunities or make outdated decisions.

Solution: Invest time in financial education. Keep up with market news, read investment books, or take courses to stay informed. This will help you make smarter investment decisions, understand market cycles, and keep up with new investment products or strategies.

Ignoring the impact of inflation

Some investors focus solely on low-risk investments like savings accounts or bonds without considering inflation’s impact on their returns. Inflation reduces purchasing power, and if your investments don’t outpace it, you may end up losing money in real terms.

Solution: Consider including assets in your portfolio that historically outpace inflation, such as shares, real estate, or inflation-protected bonds. Aim to balance risk and return by diversifying across asset classes that can provide both stability and growth.

Avoiding these common mistakes, alongside the ones previously discussed, can strengthen your investment approach. Each of these steps helps create a robust investment strategy that aligns with both your financial goals and personal circumstances.