5 mistakes investors can avoid

Making your own experiences is essential, but you don’t have to repeat every mistake that others have already made. These 5 mistakes happen again and again when investing money, but they are easy to avoid.

Mistake 1: Never try to predict the future

Do you sometimes wish you had a crystal ball that would show you tomorrow’s stock market prices? If you had one, you would probably have Apple and Google shares in your portfolio and be a multi-millionaire with Bitcoin investments today.

But hand on heart, would you really have invested your money in a computer manufacturer that was about to go bankrupt in 1997? Or invested even a single cent in a strange thing called a search engine, where no one knew how it was supposed to make any money at all? And if you did, wouldn’t you rather have chosen the then leading search engine providers Altavista, Yahoo or Lycos instead of Google?

You have never heard of these companies? That’s not surprising, some of them don’t even exist anymore, the others are only a shadow of their former greatness. And did you really know bitcoin before it cracked the record high of just under $20,000 in December 2017?

Don’t overestimate your skills in timing and market analysis

As an investor, it is best not to even try to predict the development of stock market prices. Don’t overestimate your own analytical skills either. Many things are hard to predict, even for experienced investors who get their information from the press, specialist portals or “unfiltered” internet sources. Just think of the last few years; the enormous impact of the Corona crisis on the economy and society was hardly expected.

Professional investors, with technical and personnel support, can certainly manage to beat the market. But they are few and they do their market monitoring as a full-time job and practically around the clock.

Nevertheless, many investors regularly try to predict price developments – and fail. Every now and then, an investor will succeed in entering or exiting the market with perfect timing. If it works, it is often called skill. If it doesn’t work, then it was certainly not because of one’s own skill.

And for many it didn’t work out and they preferred holding on to Lycos or Yahoo shares rather than those of Apple and Google. 

Mistake 2: Putting all your eggs in one basket and not diversifying

“Never put all your eggs in one basket.” – This age-old truism must be mentioned again and again. If only one thing does not go as planned just once, all eggs are quickly broken.

It is the same with investing. Those who put all their eggs in one basket take far too high a risk. Many investors tend to act emotionally and invest in hype stocks or in “the top investment of the hour”, for example.

Of course, anyone can put the next biotech stock in their portfolio that is “very close” to the successful development of a Covid vaccine – but just as an admixture to take advantage of opportunities or to spread the risk further. Do not let yourself be influenced by the daily flood of news and rather invest according to firm, long-term oriented principles.

Diversification – Spread your money over different investments

Try to create a portfolio that is ready for any market situation. It is best to spread your capital across various asset classes and it is important to invest in different markets and sectors, for example, not only in the German car industry or only in American tech stocks. Don’t just put money into real estate or into a single crowdinvesting project in the hospitality sector.

For investors, it is advisable to have a portfolio that is structured as globally as possible and spread across different asset classes and is also prepared for special situations such as the Covid crisis. This is exactly why the legendary investor Ray Dahlio designed the so-called “all-weather portfolio” about 30 years ago. 

Mistake 3: Accepting to high costs

The more natural ingredients are processed with industrial additives, the higher the price goods can be sold at – and the more unhealthy it usually gets.

The situation is similar with financial products. Many financial investments are basically simple in structure but are “processed” by the financial industry and thus complicated.

And what appears to be complicated and somehow well thought-out is often accompanied by very high costs. Especially complete solutions that are supposedly structured with the customer in mind often contain high fees. Building loan contracts are combined with various life insurance policies. Advertised as “safe” and “sensible”, they are actually just expensive and so complicated and convoluted that no one understands them.

For that reason, don’t get lured by well-meaning advertising promises and always pay attention to the costs of a financial product. After all, the costs have a significant effect on the effective return, even if it is “only” one or two percentage points. The impact of fees on performance can be serious over the years, as our example shows:

Investment fund with + 5.00 % performance p.a.:

Mistake 4: Making conclusions for the future from the past

People like to do it, but it is highly problematic: projecting the historical development of an investment into the future.

Just because a fund has performed well in the past does not mean that it will do so in the future. Inferring the future from the past is usually as fruitless as trying to predict share prices. You simply cannot know what the future will bring.

There are also changes in fund management, a change in investment strategy or social changes that affect the performance of many investment models.

Would you like some examples?

• The shift away from fossil fuels and the politically desired energy turnaround (keyword: nuclear phase-out) has deprived many electricity companies of their lucrative business basis.
• More photos are being taken today than ever before, but the old-established photo and camera manufacturers are not the beneficiaries of this boom. Software companies from Silicon Valley are.
• The growing ecommerce has disrupted numerous business models; but this does not necessarily mean that there will be no more “offline” businesses in the future.

One should also not be blinded by the extremely good performance of some shares or funds. A return of 20 % says little if it is not put in relation to the underlying risk. Many investors focus on absolute rather than risk-adjusted returns. This is because high returns usually go hand in hand with higher risk. The “Sharpe ratio” can be used to make a correct assessment. The Sharpe ratio can help to put returns and risk into perspective.

For example, an equity fund that has achieved a 10 % return but has crashed by 20 % in the meantime would have a lower Sharpe ratio than a fund that has only achieved 8 % but has never been in the red. Many investors would ultimately feel more comfortable with the second fund, even though it had a 2% lower return. 

Mistake 5: Constant buying and selling

“Too much back and forth makes your pockets empty.” This old stock market piece of wisdom is still valid today.

Just like the costs of a financial product, trading costs can also significantly reduce the return. Because every purchase and sale on the stock exchange costs fees. Especially for small amounts, these fees have an extremely negative effect on the return and can even turn it completely negative.

Although investors can get the feeling that they are “taking care” of their portfolio by actively reacting to the current market situation, in the end they are usually harming themselves.

Too much buying and selling can also lead to greater nervousness. It tempts them to keep looking at their portfolio and reacting to supposedly threatening or lucrative situations. Not only does this incur high trading costs, but you may even miss out on important value gains by temporarily exiting the market.

This is why the best advice is to always stay calm, keep a cool head even when bad news arise and follow a (preferably fixed) investment strategy for the long term. There is power in calm, especially when it comes to investing.