The 6 Most Costly Mistakes Individual Investors Make
Some of these mistakes are the result of simply not knowing the right things to do. However, many are the results of not taking an active interest in investing. So much money is lost when people assume things will simply take care of themselves. Here are the six costliest mistakes that individuals -- also known as retail investors -- make, and some ways you can counteract them.
1. Ignoring Investment Accounts
Likely one of the costliest mistakes is simply ignoring your investment account for years, even decades. This can result in a number of problems:
- Losing entire holdings.
- Not rebalancing to stay in line with current risk tolerance.
- Having accounts eaten away by fees.
The solution: Schedule times at set intervals to check in on your accounts. It needn't be often; quarterly, every six months or even annually will suffice. You can even choose an online broker that will allow you to set up reminders for yourself or merely mark it on your calendar.
2. Not Paying Attention to Fees
The most frustrating mistake I saw investors make was not paying attention to fees. When overlooked, these fees add up to a significant drain on your portfolio. The two most common are from trading too often and from mutual funds themselves. Trading too often can be hard to counteract, especially if you consider yourself an active trader, but keep in mind those commission fees add up.
The big fee that far too many overlook is the mutual fund fee. According to a paper by two University of Pennsylvania Law School professors, the average mutual fund fee (as of 2013) is 1.31 percent and can vary anywhere from .05 percent to more than 2 percent. If you're investing in a mutual fund that charges that average, you'll lose roughly $1,500 of a $10,000 investment over 10 years.
The solution: The large majority of these fees can be avoided by seeking exchange-traded funds that charge considerably less in fees.
3. Improperly Diversifying
Diversification, when done right, is a hallmark of wise investing. However, many retail investors believe they're doing it correctly when they're actually over-diversifying and thus exposing themselves to more risk. The problem goes back to mutual funds.
Few investors realize that a relatively small number of popular stocks form the core of many mutual funds, albeit in different allocations. So, while attempting to diversify, many investors end up highly concentrated in that pool of stocks.
Other problems arise when you pick a number of stocks to invest in and believe that makes you diversified. That is unfortunately not the case, as many times the stocks you pick will fall in the same few industries. These decisions leave you less prepared to weather a market downturn and put you at risk for increased loss.
The solution: Review each fund's top holdings to avoid duplication, and consider a variety of industries when you buy individual stocks.
4. Being an Emotional Investor
We often hear about the perils of being an emotional investor. While it may make sense to follow the herd when you're investing in stocks, it'll generally only come back to harm you in the long run. Other signs of being an emotional investor:
- Holding on to a stock, thinking it'll come back at some point.
- Selling a stock at the first sign of a loss.
- Being glued to the financial news cycle.
The solution: Stay the course and be rational -- your portfolio will thank you for it.
5. Not Investing Early Enough
I've been guilty of this myself. Many people think that either they can't afford to invest, have too little to invest for it to mean anything or can postpone investing. Whatever the excuse, the result is a lost opportunity to grow your money.
The solution: Find a way to start investing in your 20s, or earlier, even if it's in small amounts. If you have only a small amount to start investing with, many brokerages have either no minimum deposit or require as little as $250 to get started. Start with what you can and set a goal to put aside more each month. It might seem like nothing, but the point is to getting the discipline down.
6. Ignoring Taxes
I spoke with investors daily who were unaware there were taxable consequences to dividends or gains made through sale of investments. Whether we like it or not, the Internal Revenue Service wants its share -- and this can add up to hundreds of thousands of dollars when not watched.
The solution: Take advantage of tax savings available through vehicles like an individual retirement account. If you like getting dividends or trading, do so in an IRA to shelter yourself as much as you can. This also means knowing what not to hold in an IRA account, like tax-free investments like municipal bonds. Of course, this should be done in consultation with your tax adviser.
John Schmoll is the founder of Frugal Rules, a finance blog that regularly discusses investing, budgeting, and frugal living. He is a father, husband, and veteran of the financial services industry who's passionate about helping people find freedom through frugality. He also writes about wise ways to manage your money at WiseDollar.org.