The 6 most common mistakes of stock investing
Do you want to earn passive income? Yes, you probably do. In that case stock investing is one of the easiest and best accessible things you can do.
However, be aware that there are plenty of pitfalls of stock market investing. In fact, in this article I will tell you the most common mistakes of stock investing!
If you want to get your head around stock investing and buy some shares, you’ll love this guide!
Remember the words of John Bogle, an American Investor, business magnate, and author:
To become best prepared and able to follow John, let’s start with the first of the most common mistakes of stock investing…
Mistake #1: Be Impatient and Unprepared
There are two things that you should avoid when you are planning to invest in stocks: you should not be impatient and not start unprepared!
I admit, that’s easier said than done.
However, regardless of whether you are a new investor or if you are more advanced, both traits will get you in trouble. That’s simply because stock investing is a marathon, not a sprint. Of course, there are different types of investing and trading strategies. Some of them rather focus on short-term (e.g. day-trading) and others on long-term results (e.g. buy and hold).
Yet, the Yield Review is focused on long-term, high dividend stocks. That’s why I am not talking about short-term strategies but always refer to the investing marathon. You can think of it as follows:
If you wish, you could see this marathon as never ending. It’s an ongoing process in which your plan, learn, do, adjust, and celebrate achievements. If you wish, you can step out anytime. But let me tell you, the longer you stay in the game, the better your results will be. That’s simply because you become more experienced. Eventually, you can leverage this knowledge better and achieve greater results.
Again, look at the graph above showing the investing marathon. Do you see why patient and preparation are key?
They reinforce each other! Particularly, in an investing environment. When investing into stocks, you cannot just reap the rewards from one day to another. You cannot just start investing out of the blue.
Well, you can. But this will probably leave you unsuccessful and frustrated. Always keep in mind that the best things take time. Preparation takes time. Earning money on dividends takes time. But when time flies, you improve yourself and become better if you keep on learning. Eventually, you will be able to bring your knowledge into practice and you’ll be rewarded by greater returns.
Let’s turn to the second most common mistake of stock investing.
Mistake #2: Ignore Fundamental Data and Stock Valuation
Do your homework. That’s the whole story. No magic, no special effects, no loopholes.
If you want to seriously invest into stocks, you have to be knowledgeable. There are quite a few things that you should know about the stock market as well as the companies you are considering investing in.
First, you should know how the stock market functions. Learn about its basic mechanics. Meaning, you should be aware of the driving market forces and which players act with which interests in the market. Further, inform yourself about the major products available or investing strategies out there.
Second, you should know how to look at a company’s performance and its stock valuation:
You should know the companies you want to invest in or are already invested in. Make sure you have sufficient knowledge about the history of the company, its current standing, and outlook. The easiest and most complete way to understand a company is doing a financial analysis (click here to get an overview on how that’s done).
Part of the financial analysis is the fundamental analysis (again, click here to see the complete guide to fundamental analysis). The fundamental analysis thoroughly analyzes a company’s financial statements and situation. Specifically, you look at the most basic but most important financial ratios. For example, you analyze the company’s profitability or liquidity. Overall, those financial ratios tell you how the company is currently doing, but also compared to historical dates or other companies.
A stock valuation will tell you about the current and historical stock performance of a company. On the one hand, we want to make sure the dividend satisfies and provides us with our expected return. On the other hand, we want to make sure that the stock is not overvalued, and we do not pay too much.
If you know the basics about the stock market and how your company and its stock performs, you are well prepared. So when your homework is done, make sure you not fall for the next very common mistake of stock investing…
Mistake #3: Let Your Feelings Guide You
Benjamin Graham really brings it to the point. But don’t get me wrong. Of course, it’s great if you’re an emotional person and if your gut feeling works well.
However, as a long-term oriented value investor, you should never ever fully be let by your feelings and emotions. At every point in time – be it in bullish or bearish markets – it is crucial to look at and rely on the numbers. Fundamental data and stock valuation is key!
The biggest problem with feelings or emotions is that very often, you cannot fully track them down. You might be aware of their root causes but still, you cannot entirely control them. Even though you might try to suppress or control your emotions, they will sustain in your unconsciousness.
Contrarily, fundamental data and stock valuation are based on numbers. Conclusions from fundamental data are fully rational and in a first place not biased. Although you have to be more careful with stock data, it is still non-negligible when you want to invest in the stock market.
In any case, data – fundamental as well as stock data – should always be the driving force of your decisions. Primarily being guided by emotions and feelings is for sure one of the most common mistakes of stock investing.
Let’s assume that there is a sharp drop in the stock price of a company you are invested in. Would you be shocked? Would you be anxious? Maybe you would even consider selling your shares at first glance.
However, key is to stay calm. Separate your feelings from the facts. Take a step back and review your fundamental analysis of the respective company. Most likely, this has not changed. In addition, look at the stock data. On the one hand, the share price has dropped, and you have lost that amount at least for the moment. On the other hand, look at the dividend yield. By nature, the dividend yield increases as the stock price declines, but dividend payout remains the same.
Click here to recap the calculation and interpretation of dividend yield.
Mistake #4: Fall in Love with Products or Services
This is one of the most common mistakes investors are falling for. It can happen to new investors, but as well as quite experienced ones. But I tell you: don’t fall in love with products or companies. Otherwise, you’ll have a hard time…!
I know, it might be really difficult sometimes, not to fall in love with products. For example, let’s think about all the Apple followers. Those that are camping in front of an Apple store before a new iPhone model is released. They probably love the product as well as the entire company. I can totally relate.
However, that’s exactly when your investing instincts should give the alarm. Make sure to separate your emotions for a product or company and the rational thinking about it when it comes to investing.
Always stay objective and remember to stick to fundamental data and the stock valuation. Hard facts and financial metrics beat your emotions when it comes to your return on investment.
Now, let’s see what mistake #5 of stock investing is…
Mistake #5: Neglect Dividend Payout Ratio
I admit, this is a more specific but still common mistake of stock investing. However, I strongly belief that it’s one that deserves a lot more attention. In particular, because it seems to be rather insignificant and few people care about it.
The mistake I am talking about is neglecting the dividend payout ratio. If you want to recall the ratio, see this article.
More specifically, I am referring to a holistic picture that you should always keep in mind. That means, of course look at a company’s dividend yield but also at its dividend payout ratio. Especially if you’re a long-term oriented value investor, you should care about the company’s stability and sustainability of its dividend payouts.
However, if a company has a very high dividend payout ratio there is little money left within the firm. This I needed to reinvest, create capital reserves, or to invest in machinery, infrastructure, or human capital.
Contrarily, if a company has a decently low dividend payout ratio, there is money left to secure and build the future of the company. A very good example is BMW. The explicitly target a dividend payout ratio of 30%-40%.
So please avoid this very common mistake of stock investing. Keep your eyes and mind open and shape a holistic view when deciding.
Mistake #6: Don’t Accept Guidance and Support
If you have ever started something new – be it a type of sport, learning an instrument, or training any other ability – you probably know that every beginning is hard. For sure, we’ve all been there.
However, with investing it’s a bit more challenging than with some type of sport. Failing with an investment will most likely make you lose quite some money. Whereas failing with, let’s say tennis will in the worst case just make you look like a fool.
If you don’t want to fall for one the most common mistakes of stock investing reach out for support. It’s no shame to accept guidance and learn from knowledgeable sources. Go out and talk to people, to family, friends, or colleagues. Next, read! It doesn’t matter if it’s a newspaper (e.g. Financial Times, The Huffington Post), a book, a blog, or follow someone on twitter. As long as you retrieve some value and become smarter go on scanning these sources.
Last but not least, raise your voice! Let us know if you have any questions. You can ask us questions not only regarding this article, but also about investing in general, financial analysis, stock valuation, financial ratios, or accounting.
Feel free to reach out and leave a comment below right now.
Thanks for reading this article. Please, let us know if you have feedback, corrections, or any further question (either down below in the comments or via contact). We are happy to discuss and further support you along your way to becoming a “yield reviewer”.
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