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Most of us have made an investment mistake of one type or another. While you can’t avoid all investment errors, you can learn from those you’ve made — and benefit from that knowledge.
By far, one of the most common and costly mistakes involves hanging on to a losing stock or investment. There’s a very human tendency to believe in stories of big comebacks in which someone is knocked down but rises back to the top. That sentiment is how many investors look at a losing stock they own. Psychologically, it hurts to recognize you’ve lost some of the money you invested. But there’s a cost as well to hope against hope that the loser will become a winner. You could be better off selling the losing stock and putting the proceeds into an alternative investment that appears likely to have better returns.
While a lot of investors don’t want to realize a paper loss, some do the exact opposite — they avoid a realized gain because they want to avoid its tax consequences. That disdain for paying taxes can lead to holding onto investments too long. By that time, the drop in value could be greater than what they would have paid in taxes on the gain. Also, letting taxes drive their investment decisions means that their portfolios can become distorted, too heavily weighted in the stocks they don’t want to sell due to tax worries.
Other times, investors simply maintain a false sense of diversification. For example, investors who hold several different mutual funds may consider themselves fully diversified. However, if those mutual funds have identical investment objectives — say, three different mutual funds that all focus on small-cap growth companies — they’re not providing that intended diversification. In that case, the investor could gain diversity by converting one of those funds to a large-cap fund with a focus on value stocks and a mid-cap fund that seeks both growth and value stocks.
Everybody wants a piece of a shining star, and many investors catch a news bite or see a company’s stock highlighted in the media and figure it’s the next hot stock. As they hear more and more about it from various sources, investors may feel confident enough to buy. But chances are by then, it’s probably too late. A stock that’s a media darling most likely has already had a lot of expectations built into its price.
Another big mistake investors make is buying a company after a sudden price drop. To many investors, a cheap price equals a good deal. They don’t look past the market price of a stock to determine its relative value. And chances are a recent, precipitous plunge is likely the result of a significant change of circumstances in the company.
In life, some people are always looking for the next best thing or the greener pasture. For investors, the tendency to look for and trade into the next best investment can lead to excessive trading. The churn effect on investing can represent another costly investment mistake and can significantly impact any gains on the investments.
While we can’t cover all investment errors here, these are some of the most common and costly and why investors continue to make them. As the saying goes, “Those who do not learn from their mistakes are doomed to repeat them.” Sometimes knowing where you went wrong keeps you from going wrong again.
This article is provided by Pamela J. Carty, a Financial Advisor at RBC Wealth Management. The information included in this article is not intended to be used as the primary basis for making investment decisions. RBC Wealth Management does not endorse this organization or publication. Consult your investment professional for additional information and guidance.
RBC Wealth Management, a division of RBC Capital Markets LLC, Member NYSE/FINRA/SIPC