Investing Pitfalls

There are many investing pitfalls that can take huge bites out of your investments. With all the conflicting information out there, it can be difficult to know whether an investing opportunity is real or not. Our instincts and emotions make it even more difficult to have sound judgment. Here is a list of things to look out for:

• First and foremost, to prevent investing pitfalls it is important to make sure any investment opportunity passes the too-good-to-be-true test. If it sounds too easy and simple to get huge, far above average returns on your money, then its probably too good to be true. There are many "systems" out there with big promises. They might even have "proof" and will only cost you a few dollars (seemingly) to try. Don't waste your time or money.
• Use Warren Buffett, the greatest investor of our time, as a measuring stick for realistic gains to prevent investing pitfalls. He has a long term compounded annual growth rate (CAGR) of about 20% over 40+ years. Even after repeated successes, he never guaranteed that he will beat the market or even give positive returns. Not only that, but he worked constantly to make those returns, had saved $5,000 at the age of 16 in the 1940s, bought his first stock when he was 11 years old, was buying Cokes in bulk and selling them for a profit at the age of 6, and has demonstrated a near photographic memory. No one can realistically guarantee you returns anywhere near Warren's returns. So, if someone guarantees anything even close to 20% yearly returns, run the other way. I also recently saw a website that claimed you could easily get 10% monthly return on your money. That would mean you would be more than tripling your investments every year. That would mean a $10,000 investment would turn into $3 million after 5 years and $925 million after 10 years! Yeah right. When you see big claims like this, move along quickly no matter how convincing they sound.
• Don't get caught up in the extreme emotions of the crowd during big gains and losses in the market. Don't let the Chicken Littles and GoGo-ers affect your investing decisions. Especially right now, people are claiming that stocks are dead as a quality investment vehicle. Guess what? People have said the exact same thing many times before. A few years from now, they will be saying that we're in a new era where stocks will never stop going up. Don't be fooled by either. Read about the details in stock market and dow jones history to get realistic expectations about investment returns. Not being able to protect yourself from the market emotions is one of the hardest hitting investing pitfalls of them all. Essentially, people end up buying high and selling low and then claim the stock market is a bad investment.
• There's a large group of "investors" (they're really speculators) out there that have a fundamental misunderstanding of the relationship between cause and effect. The technique they use is called technical analysis. Basically, they use the historical charts of a stock to predict what the stock will do next. They find patterns that "usually go up," "usually go down," and others. Technical analysis is one of the easiest investing pitfalls to get sucked into. When I first started investing, it made sense to me because I thought that surely there's a pattern to it all and that that pattern can be found and used as a decoder ring. Our brains automatically try to find the patterns in things, but, like many things in investing, our natural instinct fails us here. Don't be fooled. The historical patterns of a stock price have no bearing on the future stock prices.
• Another group of "investors" that are really speculators are trend traders. There is a big overlap here with the technical analysis group and trend traders. Most, if not all, trend traders are also day traders. The main concept behind trend trading is to buy when something has gone up and sell when it has gone down. This is what our emotions tell us to do, but it is exactly the opposite of smart investing. When the price of socks goes up, are you more or less inclined to buy it? In order to be "successful" at trend trading, you have to pay close attention to your holdings every minute of the day or else you might miss a swing in price. That sounds taxing. Downsides to trend trading include, but are not limited to, high trading costs, pay higher taxes on earnings, high swings in emotions with big swings in gains and losses, having to stay one step ahead of the crowd that you are part of, and physically taxing to watch everything constantly. In reality, this is multiple investing pitfalls wrapped into one devestating package.
• There are also investment scams out there that you should watch out for. Always make sure it passes the too good to be true and Warren Buffett tests. Usually the scam doesn't, but it is able to reel people in because its promises are over the top. The scammers also usually provide "evidence" that demonstrates the validity of their claims. Evidence can be easily faked or misleading.
• While not exactly falling under "investing pitfalls," its important to watch out for the enticing internet business scams. Technically, you would be investing your time and money for a certain return. Usually, these fail the too good to be true test. For example, I see ads everywhere for the submitting links to google scam. For only $3 you can learn a way to make thousands from home easily! Sounds great if it works. If it doesn't, you only lose $3, right? Wrong. When you read the fine print of that, they charge your credit card $60 per month for their "services" and are very hard to get ahold of to cancel.

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