If you’re new to investing and don’t know where to start, the good news is that you have a ton of resources when it comes to learning how to invest. The bad news is that not all of those resources are helpful or accurate.
In fact, some of that information — whether it’s on social media or elsewhere — can actually spread falsehoods about investing. This misinformation can cause you to fall into mental traps that may be keeping you from building wealth.
Here are five mental traps beginning investors should avoid at all costs and why.
5 mental traps beginning investors should avoid
1. Needing a lot of money to invest.
One of the most common misconceptions about investing is that it takes a lot of money to get started. This isn’t true. There are lots of brokerages with no account minimums or fees, and some let you trade fractional shares of stocks starting with just $1.
There are also plenty of cost-effective ways to make sure your portfolio is diverse. Consider investing in exchange-traded funds (ETFs), which are funds that trade like stocks but are a basket of various kinds of securities, giving you immediate diversity within your portfolio.
ETFs and mutual funds charge expense ratios, but these are usually low. The average expense ratio for an index stock ETF in 2023 was 0.15 percent. The rise in the popularity of ETFs has caused the expense ratios of both mutual funds and ETFs to fall dramatically over time, making both types of investments convenient and affordable.
2. Wanting to sell when you experience a market downturn.
Many long-term investment advisors and financial advisors have stressed the importance of not selling all of your assets during a market downturn, and for good reasons.
First, one powerful force at work in investing is compounding. This is when your initial investment starts to grow on top of the profits you’re also earning, like a snowball rolling down a hill. If you sell your assets during a market downturn (which is a normal occurrence), you’re taking away from any compounding that might have occurred otherwise.
Second, it’s notoriously difficult to time the market. If you misinterpret a market selloff and sell too soon, you could miss out on the future potential price increase(s) of a stock.
Third, selling most of your assets within the same category or asset class (that is, all stocks or all bonds) may expose your portfolio to unnecessary risk.
The big picture: Hang onto your investments if you can. Consider why it is you really want to sell if the market is experiencing a downturn. Remember that market ups and downs are a normal part of the economic cycle over time.
3. Trying to outperform the market.
Trying to outperform the market can also lead to losses. For many investors, buying a passive index fund and holding onto it is the way to go.
S&P 500 index funds allow you to invest in the Standard & Poor’s 500 Index, a collection of stocks that includes America’s largest and most successful companies.
The S&P 500 alone has returned an average of about 10 percent annually over time, making it an attractive investment. Furthermore, actively managed funds, which are those managed by investment professionals who try to beat the market, have underperformed passive funds — like indexes that simply track the S&P 500 — over time.
This doesn’t mean diversification isn’t important. Invest in a wide range of assets, just don’t try to outperform the market by taking on unnecessary risk.
4. Day trading stocks and crypto can make you more money than long-term investing.
This statement might be true for some. You can definitely make money — sometimes lots of it — day trading crypto and stocks, if you’ve got the time and the knack for it.
For most folks, day trading requires constantly monitoring markets for price movements and making quick decisions throughout the day. Because of this, some investors who day trade make it their full-time job.
Frequent trading can also result in higher fees from whatever brokerage you’re using, eating into any potential profits you’d make from your investments. You also might incur capital gains taxes more often if you’re selling assets for more than you bought them.
All in all, timing the market takes serious skill and time, relying heavily on speculation rather than the fundamental analysis of a stock.
5. Investing without clear goals in mind.
Take the time to think about what your long-term goals are when it comes to money, wealth and investing. This isn’t a necessity, but it does help you determine your investment strategy.
Do you want to retire? If so, what kind of lifestyle do you want in your golden years? Are you going to eventually send a child to college? Do you hope to buy a house?
These are all questions you should ask yourself before investing. Outlining clear goals helps establish expectations and keeps you on track. Goals also help you determine what exactly to invest in.
For example, if you’re far from retirement but still want to start investing, you can afford to be riskier with your investments. If you’re nearing retirement, you may put more money toward government bonds and begin to shift away from riskier investments. Again, your strategy will vary based on what you want to prioritize.
Bottom line
There is plenty of information out there about good and bad investing strategies. The bottom line is that every investor will have different goals and timelines when it comes to their money. Don’t fall into the mental traps that you need a lot of money to invest, or that you need to outperform the market in order to have a comfortable retirement. Often, you can start with very little money. Growing that money into long-term wealth just takes a little patience.
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