One of the best ways to learn how to invest is to learn how not to invest. There are no perfect investors. All investors, including the most experienced professionals, make mistakes. But by learning from the mistakes of others, you may be able to avoid making some of the most common investing errors.

Failing to Invest in Stocks

Some investors will not invest in stocks because they consider the stock market to be too risky. The stock market is volatile. From one day to the next, it may swing in value significantly. But over time, stocks historically have outperformed other investments.

While past performance is not indicative of future performance, stocks, on average, have historically provided double-digit returns. The S&P 500, an unmanaged index of stocks of the 500 largest companies in the U.S., has had an average return of 18.39% for the 20 years through 2000, according to Standard & Poor. This example is used for illustration purposes. Investors cannot invest directly in an index (although various index funds are available).

More conservative investments, such as money market funds, typically provide much lower earnings. A risk assessment should be performed before investing in stocks.

Thinking Short Term

Many investors expect their investments to make money almost immediately. Investors who try to take advantage of short-term gains rarely succeed, because the stock market is so unpredictable. No one can time the market consistently.

Investment professionals typically advise that investors have at least a seven-year time frame when they invest in stocks, based on the assumption that it may take that long for the stock market to run through a typical cycle during which the market goes up and down.

Trading Too Often

Frequent trading can be both expensive and dangerous. Keep in mind that you generally must pay a commission every time you trade. The commission can range from just $8, if the trade takes place on the Internet, to hundreds of dollars.

Investors who make frequent trades do so because they are betting that the stock they are selling is at its peak and the stock they are buying is not. Unfortunately, you can’t time the market. Investors who try to guess what the market is going to do are frequently wrong.

Following Hot Tips
Investing newsletters and various financial publications have provided investors with hot tips for years, but now the Internet has made hot tips ubiquitous. Even if you don’t collect hot tips from financial newsletters, off of message boards, or from your Uncle Lou, hot tips are likely to show up, unsolicited, in your e-mail.

Unfortunately, most hot tips turn out to be not so hot. By the time you receive the tip, so have hundreds of thousands of other investors. The tip itself may cause the price of the stock to rise, so by the time you invest, it may already have increased in price. When the price of a stock is artificially inflated because of hype, it typically returns to its previous level quickly.

How accurate are hot tips? Tracking the stock recommendations of four personal finance magazines for more than a year, The Los Angeles Daily News found that prices decreased for half of the recommended stocks, even though the market was booming during the period the study took place.

Failing To Research Before You Invest

The more you know about a stock, the more likely you will be able to pick a winner. For starters, find out the stock’s current price-to-earnings ratio and its beta factor, which measures the stock’s level of risk. What do analysts think about the stock? If it is a mutual fund, what is its past performance? Does the fund have a load? Review the company’s annual report, and track the stock’s performance for several weeks before investing.

Failing To Diversify

Diversification is perhaps the most important principle of portfolio management. If, for example, you invest only in the stock of the company where you work, or if you are invested in only one industry, you are subjecting your portfolio to a high level of risk. If the company or the industry you’ve invested in performs poorly, your entire portfolio can suffer.

Conversely, if your investments are highly diversified, the impact of any one stock will be minimal. To diversify, begin by making certain your investments are appropriately divided into three major investment groups – stocks, bonds and cash, which includes liquid investments, such as money market funds. An investment in the money market is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Next, make certain your stocks are diversified.

Each mutual fund invests in an average of more than 100 stocks, so it provides diversification automatically. Even if you stick to investing solely in mutual funds, you should still – at the very least – consider investing in a large-cap fund, a small-cap fund and an international fund. Investments in small companies present greater risk of loss than investments in larger, more-established companies. In addition, special risk considerations are associated with investments in non-U.S. companies, including fluctuating foreign exchange rates and foreign government regulations.

Having Overlapping Investments

When your investments overlap, you are not as diversified as you think you are. For example, some investors buy global funds so that their portfolio will not be completely dependent on the performance of the U.S. stock market. But global funds invest in U.S. equities, as well as foreign equities. Assuming you already have plenty of American stock in your portfolio, you may want to consider investing in an international fund.

Investing In Sure Things

There is no such thing as a sure thing. Investments that promise high returns and low risk are scams. High returns are accompanied by high risk, while, conversely, low risk investments generate low returns.

Buying A Stock That Just Dropped in Price

Don’t assume that a stock is a bargain just because its price plummeted. Find out why the price dropped. While buying low and selling high is every stock picker’s goal, you may very well end up buying low and selling lower.

Doing It All Yourself

Successful investing takes a great deal of time and knowledge. Many individuals have both and are successful investing on their own. Many more do not.

If you want to be a do-it-yourself investor, consider joining an investment club and read as much as you can about investing. Start small and see what happens. Follow the market daily. Every dollar you save in commissions could potentially add to your returns. However, if you do not have the time or the knowledge to manage your own investments, use a professional.