In this post, we will discuss my seven biggest investing mistakes. But first, here is our disclosure:
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Learning from our mistakes
I have been investing for over 20 years, and I have made a lot of investing mistakes along the way. It is one of the main reasons I created Crash Test Money. My goal with this website is to share my experiences with money, whether good or bad. Ultimately, I believe that we learn more from our mistakes than from our successes.
So, let’s get right to it. Here are my top 7 biggest investing mistakes.
Investing Mistake #1: Buying the hype
The year 2021 was all about cryptocurrency. It was dubbed the “crypto craze.” Bitcoin reached new heights, climbing up to $60,000. Eventually, I could not resist the urge and wanted in on the crypto craze.
However, instead of purchasing cryptocurrency, like Bitcoin, I opted to invest in the largest crypto exchange in the United States, Coinbase. I believed investing in a company regulated by the United States was safer than buying a cryptocurrency that was not regulated. Boy, was I wrong!
It was bad enough that I was buying into a bubble right before it burst, but I managed to make it even worse. How? I bought Coinbase right after its IPO. That was not a good idea.
So, not only did I buy into the hype of crypto at its peak, but I also bought into the hype of an IPO that was part of the crypto craze. I do not know if anyone can make a worse investment decision than mine.
How bad was my decision?
I bought Coinbase at $337.99 per share in April 2021. By May 2022, I sold my shares at a per-share price of $55.75. My total loss on Coinbase was over 80%. It is by far the worst loss, percentage-wise, that I have ever incurred in a single stock position.
Check out my blog post, “Crypto and My Strange and Disastrous Year,” to learn more about my wild ride with Coinbase.
To learn more about financial bubbles, check out the book “Boom and Bust: A Global History of Financial Bubbles.”
How to avoid it
Speculating is not investing. It’s gambling. I took a gamble on the crypto craze and lost big. There is nothing inherently wrong with taking a chance. However, it is important to make sure you do it with money you can afford to lose.
The saving grace for me is that I only bought a handful of shares using money that I designate as “play money.” Therefore, the losses to my overall portfolio were minuscule. Now imagine the outcome if I had bought hundreds of shares using a chunk of my investment dollars. The outcome and my finances would have been much worse.
So, if you want to take chances, I strongly encourage you to set up a “play fund.” This way, you keep your “play money” separate from your other investments. This is precisely what I do. The bottom line is you do not want to destroy your financial future on a speculative bet. As the great Benjamin Graham wrote in “The Intelligent Investor“:
“Never mingle your speculative and investment operations in the same account, nor in any part of your thinking.”
Benjamin Graham, The Intelligent Investor: The Definitive Book on Value Investing
Investing Mistake #2: Letting fear take over
I got out of college at the height of the dot-com bubble. Lucky for me, I had not started investing yet. If I did, I have no doubt that I would have gotten caught up in the tech craze and lost my shirt.
Although I didn’t lose any money during the dot-com bubble, something interesting occurred. First and foremost, It caused me to be hesitant about investing, delaying my entry into the market. Then, my initial caution about owning tech stocks soon turned into an irrational fear. I reacted to this fear in a similar way to those who experienced the Great Depression. Many people who lived through that time developed a profound distrust of banks and stocks and never placed their money in them.
So, when I started investing a few years later, my fear of another dot-com bubble made me avoid tech stocks. When Google went public a few years later, I refused to buy even the smallest of stakes in it. I had convinced myself that all tech stocks were overpriced and would eventually crash. Unfortunately, this overcorrection prevented me from entering the market at the best time (when it was beaten down) and taking advantage of some good opportunities in the early days of my investing.
How to avoid it
The biggest lesson I learned is that the market bounces back, even after the horrible dot-com bubble.
It is good to be cautious, but when that caution turns to fear, it can become irrational and do more harm than good. The dot-com bubble and the fear it generated delayed my entry into investing and led me to make irrational decisions.
One way to counteract that fear is to invest in a broad-based index fund like an S&P 500 or a total market index fund. By doing so, you will own all of the sectors of the economy and limit the damage of frequent trading. Of course, once you buy into the broader market, it is best to take a buy-and-hold approach with those investments.
Another way you can counteract your fears is by making your investments automatic. Making investing automatic will keep you investing regardless of whether the market is going up or down and help you avoid timing the market.
This approach served me well six short years later during the Great Recession. Was I afraid? You bet. Like everyone else, I saw my investments cut in half. However, I did not sell a single investment and never once paused my automatic investments in my 401K or IRA. By continuing to invest, I was able to buy into the market at prices not seen in a long time.
As a quick side note, I have shifted most of my investments to index funds over time. By owning a low-cost S&P 500 or total market index fund, you can achieve instant diversification and keep more investment dollars working for you instead of going to fees. Owning an S&P 500 index fund (or any investment) will not protect you from losses as it will have down years. However, I would rather bet with it than against it.
I highly recommend “The Little Book of Common Sense Investing” by John C. Bogle if you want to learn more about index fund investing.
“The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Little Books, Big Profits)“
By John C. Bogle
Investing Mistake #3: Not doing research
One of my very first investing mistakes was not conducting adequate research before buying individual stocks. It was also thinking that I could beat the market.
After the Great Recession, and with markets down big, I decided to try my hand at buying individual stocks. I settled on Alcoa, a company that specializes in aluminum.
Why, out of all of the thousands of publicly traded companies, did I choose Alcoa? Simple. I based my decision on one article on a financial website that recommended Alcoa.
I knew nothing about aluminum or material stocks. All I knew was that aluminum prices were down after the Great Recession, and Alcoa was trading at levels not seen in decades. It was also part of the Dow Jones, so I felt I was buying a beaten-down blue chip stock on the cheap. However, sometimes stocks are cheap for a reason and not just a causality of a down market. I would come to find that out the hard way.
The irony was that owning a dull blue chip company turned out to be a wild investing adventure. The drama was straight from a reality TV show. I chronicle it all in my post “Stock Picking Is Risky, Here Is My First Big Failure.”
Long story short, I held Alcoa for a decade. During that time, it split into three separate companies. All three companies traded flat for most of that decade, and I held on the whole time! Eventually, I would sell all my shares and make a decent profit. Yet, it was nowhere near what I would have earned had I just invested in a simple S&P 500 index fund.
How to avoid it
My investment in Alcoa made me aware of the dangers of picking individual stocks. It reinforced the need for a “play fund” and to not take outsized bets on individual stock positions. However, the biggest lesson from this experience was that it taught me that investing is emotional and most investors are their worst enemies.
A few years later, I stumbled across the concept of behavioral finance. That opened my eyes to my investing mistakes. I realized I held on to Alcoa for far too long because I did not want to sell at a loss. Once I discovered behavioral finance, I never looked at my past and present investments the same way again.
I encourage all investors to learn about behavioral finance and how your aversion to loss and biases impact your investment decisions. To learn more, check out “The Little Book of Behavioral Investing: How not to be your own worst enemy,” at Amazon.
One helpful piece of advice I found is to write down why you chose an investment when you initially bought it. Then, you can go back later, see your thought process, and learn from it.
This is because hindsight is 20/20, and we have a hard time accepting when we are wrong. Often, we will rewrite history to avoid facing our errors. A written log of your decision-making process will help you learn from your investing mistakes.
Investing Mistake #4: Chasing dividends
When inflation rose in 2022, I decided to take a chance on mortgage REITs. Mortgage REITs are not like traditional REITs that own real estate properties. Instead, they own the debt associated with those transactions. In other words, they own mortgages and mortgage-backed securities. This would become one of my worst investing mistakes.
Mortgage REITs are tempting because many offer double-digit dividend yields. However, with sky-high dividends come sky-high risks as these companies are highly leveraged. Since mortgage REITs are all about making money off of debt, they tend to suffer during periods of high inflation. So why did I buy mortgage REITs during the worst inflation in 40 years?
I was banking on two things. First, I was hoping to buy mortgage REITs when they were cheap. Second, I believed that shares of mortgage REITs would increase as inflation eased. Until then, I could rely on their double-digit dividend yield to cushion my losses. Things did not go according to plan.
I had double-digit losses in my mortgage REIT positions. This is despite reinvesting the dividends that were running at double-digit yields. Meanwhile, over the same period, the S&P 500 rebounded from its bear market while providing a modest dividend yield below 2%.
How to avoid it
Dividends are important and account for a big portion of the market’s returns. However, basing your stock picks on dividend yield alone is dangerous. In general, a higher dividend yield usually indicates a greater level of risk. This is because a high dividend yield is often the result of financial difficulties or a company operating in a high-risk industry, such as mortgage REITs.
If you are trying to generate stable income from your investments, it is best to invest in companies with a long, stable track record of paying out and increasing their dividends. For instance, you can invest in “Dividend Kings” or “Dividend Aristocrats.” Dividend Kings are companies that have paid and increased their dividends for 50 consecutive years or more. Dividend Aristocrats have done it for 25 straight years or more.
You can also keep it simple and invest in a low-cost S&P 500 index fund. It may not provide the highest dividend yield, but it offers diversification. Also, many (if not all) dividend kings and aristocrats are included in the index.
Oh yeah. I almost forgot. You might be wondering what I did with my mortgage REIT investments. I sold them all.
Investing Mistake #5: Buying into Gimmicky Strategies
The gimmicky strategy I tried was the Dogs of the Dow. I decided to try out the Dogs of the Dow investment strategy for Crash Test Money with the intention of sharing my experience. So, while it may not be a classic example of one of my investing mistakes, it still hasn’t gone well.
The Dogs of the Dow investment strategy attempts to invest in undervalued blue-chip companies with dividend yield as the only metric. On the last trading day of the year, you identify the ten companies with the highest dividend yields in the Dow Jones and invest equal amounts into each at the start of the new year. You repeat this process every year, swapping out stocks as needed.
While not the worst strategy, the Dogs of the Dow does not consistently beat the S&P 500. To make matters worse, it is not a buy-and-hold strategy. The problem is that frequent trading is known to hurt returns. This is never truer than if you hold the Dogs of the Dow in a taxable account.
Remember, you rebalance the Dogs of the Dow portfolio every year by selecting the companies with the highest dividend yields from the previous year. This strategy, more often than not, will result in selling your winning stocks, leading to capital gains taxes. The capital gains taxes you pay may wipe out any advantage the Dogs of the Dow may have had.
So, to sum it all up, the Dogs of the Dow investment strategy does not consistently outperform the S&P 500. In years that it does, their advantage may be wiped out by taxes.
how to avoid it
Although the Dogs of the Dow investment strategy occasionally outperforms the S&P 500, I don’t believe it’s worth it. It might have some good years, but as 2023 has shown, it can also have some awful years.
So far, 2023 has been a rough year for the Dogs of the Dow, while the S&P 500 has thrived. Yet, I will hold onto the Dogs of the Dow through the end of 2023 as I am committed to seeing it through. After that, I am done with this strategy. I may keep a few stocks I like for the long term, but I will sell the rest.
The fact is that it is tough to beat the S&P 500. Plenty of investment strategies claim they can, but how many can do it consistently year after year? Not many.
I believe limiting individual stocks to a small percentage of your portfolio is best due to the risks associated with picking them. Whether we like it or not, when it comes to selecting individual stocks, luck and chance may have a greater impact on performance than any gimmicky investment strategy.
Check out my posts “Going in on the Dogs of the Dow 2023,” “Dogs of the Dow 2023, All Bark No Bite.” and “The Dogs of the Dow Quickly Devoured My Returns” to learn about my experience with the Dogs of the Dow strategy.
Investing Mistake #6: Sector Investing
Many mutual funds concentrate on specific sectors of the economy, such as information technology, consumer staples, utilities, energy, and healthcare. In total, there are 11 different sectors in the stock market, and hundreds of mutual funds are available to cater to each. I have invested in sector mutual funds twice in the past, but both times, the results were mediocre and lagged behind the S&P 500.
Investing mistakes on top of investing mistakes
Right after the great recession, I invested some of my money in a mutual fund specializing in consumer staples. The economy was in freefall, and I thought placing some of my money here would smooth out the ride. It didn’t.
Over the past decade, my investment strategy of focusing on consumer staples paid off only once, in 2022, when inflation peaked. During that time, the consumer staples fund I invested in lost approximately 0.5%, whereas the S&P 500 saw a decline of about 18%. However, this provided little consolation as the S&P 500 gained almost 12% annually over the last ten years, while my consumer staples fund only managed to gain around 7.7% per year.
A few years ago, I took another chance on sector investing. This time, I invested in the healthcare sector, which was a hot sector then. I thought it was a wise choice, given its impressive track record. However, things didn’t turn out as expected, and my investment went downhill fast. The healthcare sector, which I once considered a safe bet, was a complete disaster. Its three-year return fell into negative territory in 2023.
To add insult to injury, I was paying higher expense ratios for the luxury of subpar performance. The expense ratios for both are around 0.7%. That may not seem like much, but when you factor in the power of compounding, these small costs add up over time.
how to avoid it
Investing in sectors can be challenging due to their volatile nature. A sector that’s hot one moment may become cold in the next. If you are going to try sector investing, then it is important to understand the boom and bust cycle of different sectors during various stages of the business cycle. Entering a sector at the wrong time can lead to years of disappointing returns.
In my experience, there is too much risk of getting it wrong. As you have seen, I have tried sector investing and failed. I would have been better served by investing all those dollars in a low-cost S&P 500 or total market index fund. By doing so, I own all of the sectors of the economy. This approach minimizes the risk of concentrating your investments on just a few sectors.
Investing Mistake #7: Chasing Past Returns
Let’s go back to my investment in the healthcare sector. Why did I decide on that investment?
My sole reason was that the fund had outperformed the S&P 500 in the past. I put no more thought into it. I was chasing past returns. It is as simple as that. That one simple approach was one of my biggest investing mistakes, leading to subpar returns.
How to avoid it
More often than not, chasing past returns leaves you on the wrong side of those returns. The truth is past returns do not guarantee future returns. I know it is cliche, but it’s true. It does not matter if you invest in individual stocks, the latest investment fad, or an S&P 500 index fund.
I have tried chasing returns off and on over the years, and each time, I have failed miserably. As we saw, chasing returns is how I got into sector investing. You see how well that did for me!
All those years of chasing past returns are long enough for me to know when to give up. As a result, I have sold off my position in the healthcare sector. Now, I am happy to take whatever returns the S&P 500 wants to give me.
My Investing Mistakes: What it All Means
Looking back on my investing mistakes, it’s clear that I’ve spent a lot of time and energy trying to outperform the S&P 500, with disappointing results. I’m exhausted just thinking about all the strategies I’ve tried! The truth is that many investors fall into the same trap of underperforming the S&P 500 because they make similar investing mistakes. Ultimately, we tend to overcomplicate our investments, and that’s precisely what happened to me.
In my over 20 years of investing, I have learned that keeping it simple is key. I have found that investing in low-cost index funds that track the broader stock and bond markets is best. From my experience, the more I deviate from this approach, the worse my returns have been.
I still enjoy trying to beat the market by buying individual stocks or actively managed mutual funds. But, I have come to understand the importance of risk. Therefore, I limit my investments in those areas to money I can afford to lose. I will not risk my financial future by investing heavily in individual stocks, or the next hot investing fad. Instead, I prioritize broad market-based index funds as the foundation of my investment strategy.
Ultimately, all I want is to match the returns of the S&P 500 while taking some small chances. This is my measure of success, considering many people try to beat the S&P 500, but the person who can do it over the long term is rare.
Always remember what Benjamin Graham wrote in “The Intelligent Investor”:
“Never mingle your speculative and investment operations in the same account, nor in any part of your thinking.“
We would all be wise to heed his advice.
