I started investing about 11 years ago, and my wife started more recently, in 2017. Though we started investing at different times and at different ages, we both made a lot of mistakes in our first year. Amateur investors often end up losing money when they first enter the market, either because they are overconfident, overcautious, or just have no idea what they’re doing. Here are some of the mistakes my wife and I made so that you can hopefully learn from them and make better decisions.
1. Focusing on potential gains while ignoring risk
When I first started investing, I did not have much money to invest, and, like many amateur investors, I wanted to get rich quick. To do that, I decided the best option would be to put all of my money into several different penny stocks (diversifying, right?). I figured that the only way to make decent money when you started out with little was to buy a lot of shares of a company with a very low stock price. Then, if that company went up a little bit, I would make a lot of money.
For example, with $1,000, I could buy 10,000 shares of a stock priced at $0.10. If that stock went up just 1 cent, I would make $100. If it jumped a dollar (which didn’t seem unreasonable to me at the time), I’d be up $10,000! On the other hand, if I’d used $1,000 to buy a stock priced at $100, I could only buy 10 shares. A dollar increase would only give me $10. Clearly, penny stocks were the way to go.
Unfortunately, I completely ignored the very real possibility that my stocks could go down, and penny stocks are by no means a safe investment. Just as I could gain $100 if the stock went up 1 cent, I could also lose $100 if it went down 1 cent. Plus, penny stocks tend to go bankrupt (and often pretty quickly). Very few if any of the stocks I purchased in that first year are still around today. Everyone likes to think about the potential upside of owning stocks, but it’s equally important to also consider the potential risks. If an investment opportunity seems too good to be true, it probably is.
2. Not understanding bid and ask prices
Another mistake I made as a new investor was thinking that the current market price shown for a stock was the price it actually trades at. When I was investing in penny stocks in that first year, I set a limit sell order to sell one of my stocks once it jumped a dollar so that I could take advantage of a sudden price spike even if I was at school at the time. This actually did happen on one occasion. I saw that the price had jumped to what I had set for my limit, and I was ecstatic, thinking that I had made a lot of money. However, the sell order never executed because the bid price was below the market price. I ended up missing out on the price spike.
So what prices do stocks actually trade at? These are called bid and ask prices. The bid price is the highest price a trader is willing to pay for a security, while the ask price is the lowest price that the owner of a security will sell it for. You buy a stock at the ask price and sell it at the bid price. The ask price is always higher than the bid price. The difference in bid and ask prices are due to supply and demand. The smaller the bid-ask spread, the more liquid the stock is. Penny stocks are not generally very liquid, so they tend to have large bid-ask spreads, hence my mistake.
3. Selling when the market dips
We’ve probably all been guilty of this one at one time or another. The market dips suddenly, and we panic, selling to try to hold on to any gains we may have had or to try to prevent catastrophic losses. Then the next thing we know, the market has recovered, and we lost money for no reason. We let our emotions get the better of us. This helps to explain why average investor returns are below average S&P 500 returns. When the market dips, you should hold on to your investments. Emotions and investing don’t mix.
Keep in mind that this is only for the market as a whole. If an individual stock begins to consistently underperform the market, it may be time to reevaluate whether you should hold on to it.
4. Trying to day trade
A mistake that pretty much every amateur investor has made at least once is trying to day trade. This is when you buy and sell securities in a single day, trying to time the market to make quick money. It’s an alluring concept, especially for new investors who tend to think short term. However, it often ends in heartbreak.
Both my wife and I have experienced this ourselves. Years ago, after receiving a $200 speeding ticket, I was frustrated and wanted to earn the money back as quickly as possible. To do this, I attempted to day trade. I looked up one of the stocks making the biggest jumps that day and hopped on to the momentum train. Unfortunately, of course it immediately declined and I ended up selling at a loss of about another $200. Rather than making my money back, I ended up doubling my loss. This is the problem with trying to ride short-term stock movements. By the time you notice that they are doing well, they are often nearly at their peak. For example, consider the recent GameStop drama. The people who got in early could have made a lot of money (provided they actually sold after the stock price soared). However, those people who tried to jump in after seeing GameStop in the news mostly ended up losing money, and many of these people were new investors caught up in the hype.
My wife’s experience with day trading was quite different, more like what you would envision when you picture day trading. After watching some videos on YouTube about investing, she decided to try following their method of day trading volatile, leveraged ETFs. She managed to make money on some days, but lost it on others. Overall, she ended up mostly flat. The biggest problem with day trading, according to her, was that it was way too time-consuming. She was pretty much completely glued to her phone and computer screen all day long while making these trades. And then to not end up making money while spending all this time was incredibly frustrating.
Based on our experiences, I believe that day trading is best left to the pros. For new investors, it’s much less stressful, less time-consuming, and more profitable to invest long-term in diversified securities.
5. Not taking advantage of dividend reinvestment
This is a mistake I didn’t realize I was making until I was doing the calculations for my article “Should You Wait To Buy The Dip? Why This Strategy May Cost You.” Many new investors overlook dividends or see them only as a way to earn a little income from their stocks. However, dividend reinvestment can have enormous power over the long term. For instance, over the past 10 years, the total return of the S&P 500 was 194% (11.4% annualized). Including dividend reinvestment, the total return was 256% (13.5% annualized). This ignores the dividend money that would just be sitting in your account if you didn’t reinvest it, but as that money would not continue to grow, the total would still be less than with reinvestment.
Dividend reinvestment allows your money to keep compounding in the market. If a stock is doing well, dividend reinvestment allows you to buy more to benefit from continued growth. If a stock is doing poorly, it allows you to lower your average cost basis, which can help to provide an even greater return in the long run. Either way, your money continues to grow. To read more about dividend reinvestment, check out this article: “Should You Reinvest Dividends?“
Conclusion
Everyone makes mistakes as a new investor. Even experienced investors still make mistakes. The goal is to learn from these mistakes to make better decisions in the future. This is by no means a comprehensive list of investing mistakes. Always keep in mind that investing is a risky endeavor. Make sure to weigh the costs and benefits before making investment decisions. I know how tempting it is to act rashly on occasion, but you’ll be better served by taking the time to learn more about investing so that you can do it more rationally.
Cozy Nest Egg 