Top Ten Mistakes Made by Online Investors - dummies

Top Ten Mistakes Made by Online Investors

By Matt Krantz

With its jargon, formulas, charts, and Wall Street slang, investing online can seem scary and intimidating. For some investors, the thought of managing their money by themselves is overwhelming. The fear of making a mistake and losing hard-earned money is too much to bear. Most of the mistakes investors make can be neatly placed into the following ten categories.

Buying and selling too frequently

One of the greatest things about online investing is that it gives investors the power to buy and sell stocks whenever they want. Unfortunately, though, some investors turn this 24/7 access to their portfolios and stock trading into a liability.

Constant access turns some investors into obsessive portfolio checkers and trigger-fingered investors who can’t help but trade.

Letting losers run and cutting winners short

Human nature, in some respects, is your worst enemy when investing online. Humans react in particular ways when faced with certain circumstances, but those reactions can work against you in investing. Two of those elements of human nature are defending bad decisions too long and cashing in on good decisions too early.

Investors who buy an individual stock that collapses often hang onto it, figuring that “it will come back” because “it’s a good company.” When you’re buying individual stocks, it’s critical that you cut your losses. Pick a percentage you’re willing to risk and stick with it. You can use stop market orders or protective puts.

Other investors make the opposite mistake by cashing in winning stocks too soon. Say your asset allocation tells you to put 20 percent of your stocks in emerging markets, so you buy an emerging markets index mutual fund.

If emerging markets soar in the following few weeks, but your emerging market index fund still accounts for 20 percent or less of your portfolio, you should resist the temptation to sell it all to lock in your gains. Instead, you should stick with your asset allocation.

Focusing on the per-share price of the stock

The fact that one stock is $2 a share and another is $500 a share tells you absolutely nothing about either stock. The $2-a-share stock might actually be more expensive than the $500-a-share stock because it either doesn’t grow as rapidly, doesn’t earn as much relative to its stock price, or is riskier.

A stock’s per-share price is meaningful only if you compare it with something else. Typically, investors multiply the stock price by the stock’s number of shares outstanding to get the company’s market value or market capitalization. A stock’s market value tells you whether a stock is small, medium, or large, and gives you a good idea of its valuation.

Failing to track risk and return

For some reason, prudence often vanishes when it comes to online investing. Many online investors, perhaps because it takes some effort and practice, don’t take the time to see how much risk they’re taking on to get the reward they’re expecting from stocks they buy.

The biggest danger of investing without knowing your risk and return is that you gamble not knowing whether you’re doing more harm than good to your portfolio. You might be spending a great deal of time and effort buying individual stocks, thinking the effort is worthwhile, but it might turn out you’d be better off buying and holding index mutual funds.

Instead of burning hours looking at stock charts, you might be better off spending the time with your family, on hobbies, or at work.

Taking advice from the wrong people

It’s almost hard not to get stock tips. Turn on the TV. Talk to people sitting next to you on an airplane. Chat with other browsers in the financial section of the bookstore. Connect with other investors online. You’ll constantly encounter people who are convinced that such-and-such a stock is going to take off and that you need to buy in now.

Unless Warren Buffett is the guy sitting next to you on the airplane, you’re better off politely nodding and wiping your memory clean of all the investing advice you get. Stick with your asset allocation plan.

Trying to make too much money too quickly

As an investor, you need to appreciate that wealth is built over time as companies you’ve invested in expand their revenue and earnings. Generally speaking, stocks have returned about 10 percent a year. You may be able to boost that 10 percent a bit with smart asset allocation and exposure to riskier types of stocks like emerging markets and small companies.

Some investors, though, just aren’t satisfied with that. They chase after brand-new IPOs, pile into stocks that have been the market’s leaders, and load up on penny stocks. These investors are typically the ones who get sucked into “get rich quick” e-mails, stock conferences, and other dubious stock promotion schemes that make only their promoters rich.

Letting emotions take over

The stock you fall in love with is the one that you happened to buy at just the right time and have never lost money on. It’s easy to be proud of a stock just like parents who see their kid’s name in the paper for being on the honor roll.

Periods of self-doubt and second-guessing account for many investors’ worst decisions. These investors might be so blinded by their enduring affection for a stock that they proudly ride it down lower and lower.

If you let your greed for huge returns and fear of losses run your investment decisions, you can practically guarantee you’ll buy and sell at the wrong time.

Blaming someone else for your losses

No one likes to lose money on stocks. And everyone loses money on stocks from time to time. It’s how you react to the losses that makes the difference. Some investors go on a witch-hunt and start trying to track down anyone who might have mentioned a stock as a good buy, ranging from publications and websites to friends or the company’s executives.

Ignoring tax considerations

Many investors ignore or aren’t aware of ways of investing that can save them thousands on taxes. Uncle Sam offers extremely generous tax breaks for investors, if you just know how to take advantage of them. Look into them or speak with an accountant when you begin investing. Don’t forget that tax laws and breaks tend to change from year-to-year.

Dwelling on mistakes too long

It’s important to not let a mistake in the past paralyze you. So, you bought a stock and rode it down too long before selling it. Don’t linger on the mistake. Just don’t do it again, and over time, you’ll obtain the success in investing you’re shooting for.