Top 3 Mistakes Made By New Investors
With the massive amount of information out there for new investors to consume, learning about investing can be a confusing journey. There are thousands of books and millions (I’m guessing) of blogs out there talking about how to invest in the stock market. Due to this information-overload, new investors may end up making many mistakes in the stock market.
From my own experience in the past, and from observing many new investors in the market, here are the top three mistakes I feel many new investors are committing.
Going for “cheap” companies
Warren Buffett is likely to be one of the first few people new investors learn about when they’re starting their investing journey. This would also mean that the first (or first few) book most people would read about investing is most likely The Intelligent Investor, written by Buffett’s mentor Benjamin Graham.
It is a great book – highly recommended by Buffett – and one of my favourite investing books of all time. However, the investing concept of “Margin of Safety” that’s discussed in the book may cause some confusion with new investors. Many new investors tend to assume that having a good margin of safety when investing in a stock means that they have to hunt for stocks that are trading very “cheaply” – in other words, stocks with low price-to-earnings (PE) or price-to-book (PB) ratios.
Unfortunately, many of these “cheap” stocks are cheap for legitimate reasons. Most of the time, they are poor quality businesses. So, a new investor who only focuses on buying “cheap” stocks may end up with a portfolio of terrible businesses that are unable to grow their values over time or have a sustainable future.
From my experience and after many years of hunting for all these poor-quality companies myself, I realized that it is always better to start out by focusing on the quality of a business first before worrying about its valuation. In the long run, what we want is to buy good companies at a great price, rather than catch terrible businesses at a low price.
Swinging at the fences
Whenever you start out learning something new, there is always an urge to start imagining yourself at the finish line. For example, if you are learning guitar, you might feel the need to buy a gorgeous Les Paul right away to feel like you are Slash. Similarly, in investing, you may already be tasting the millions you will be “making” when you first buy a stock.
And maybe it is this psychological quirk that nudges new investors to look for exciting stocks that can double their money quickly. Investing in a pharmaceutical company nearing an FDA approval of a magical drug, a Singapore-based supermarket operating entering the China market, or an Australia mining company that can potentially become the world’s largest miner all sound very exciting. But they are also risky. Too often, new investors are too eager to start making money that they miss out on understanding the risks of investing in this type of companies.
Sure, there is some chance that some of these companies would be the next legitimate big thing. But more often than not, they will just be another company that fails. Therefore, investors need to think about the risks of a company before they invest in anything.
Buying too much
Taking bets on risky companies that have a binary chance of success or failure is fine – if the size of the bet is appropriate for the risk taken. Buying too much of such investments can spell big trouble for investors.
Imagine if you bought that mining company in Australia mentioned above with 50% of your wealth. If the company fails, you would lose the entire half of your wealth. How long would you need to make that type of losses back?
Thus, it is important for new investors to think about portfolio weightage when they are buying a company, especially a risky one.