Avoid Investment Mistakes

Investors make two prominent investment mistakes, both of which cost them money and time. The first stems from ignoring valuation and risk versus return. The second results from forgetting their sense of perspective in investing.

Ignoring the Valuation or Risk versus Return

Ignoring the valuation and risk versus return ratio is a critical error. There are many excuses for bypassing evaluation, and none of them are advisable. You should rarely ever purchase investments above their value and set yourself up for loss by ignoring their risks. You should only purchase investments if you understand the analysis process behind the estimation of their equity value.

There’s several ways you can set yourselves within this trap, directly or indirectly. Speculators engage in this behavior, purchasing investments simply because they hope others will pay more for them or purchasing them because everyone else is as well. If higher buyers never materialize, they are caught holding the bag when the price drops on the asset. Purchasing investments because firms offer products an investor uses qualifies as ignoring valuation and risk versus return. Investors often make this error hoping that a strong product or service offering will automatically result in great profits. Often they don’t since this line of thought ignores costs of operations, financing, administration, and the effects these have on profit. Product and service line driven investment ignore the company’s fundamental situation. You cannot afford to incorrectly analyze stocks in the long or short run. Picking stocks based on an incorrect or incomplete idea of value and risk versus return is essentially gambling without knowing the odds.

Forgetting Perspective

The second major error that you can make is forgetting your sense of perspective. Investors often forget that investment is a long term game and that the short term does not represent the long term. They often exaggerate their safety in the long run based on short term gains. They ride the market bubbles until their portfolio crashes, forgetting valuations or operating on an increasingly carefree approach to risk management, or they ignore risk completely. This has been seen many times in the last two decades alone. This has occurred in the “what’s valuation” approach to technology companies, and the loaning of sub-prime based assets which ignored if borrowers could pay mortgages. Even professional investors have been prone to ignoring the fact that stock runs don’t last forever and don’t operate on expectations. Market correction always sets in, and when it does prices move downwards towards real value, not upwards to investor’s excessive expectations.

In down markets, investors make the opposite mistake. They overestimate their immediate danger based on short term loss, selling out of investments they should keep. They also often miss opportunities that appear out of fear. Some clear out of markets completely, scared that asset values will continue to decrease and evaporate all of their wealth. To be clear, selling out of falling assets in favor of capital preservation is often a wise move. Staying out of the market when financially and fundamentally sound companies offer assets that are at fire sale pricing is not. The best time to purchase financially sound stocks is when no one else will since that’s when they are the cheapest and will give the best returns over the long term. Give yourself a good deal and invest when asset prices are down.