There's no single correct way to invest in the stock market, but certain mistakes can be costly. Unfortunately, some of the most dangerous mistakes also seem harmless, making it difficult to know the toll they're taking on your savings.
By learning to recognize some of these pitfalls, though, you can set yourself up for investing success. Here are three of my worst mistakes from early in my investing journey -- and how you can avoid them.
1. Panic-selling during periods of volatility
The first time the market dipped after I began investing, I panicked and immediately withdrew my money. Even though I knew these ups and downs were normal for the stock market, seeing my account balance drop overnight was tougher than I imagined it would be.
Image source: Getty Images.
I immediately regretted my decision, though, when stock prices quickly bounced back and I realized the gains I had missed out on by selling. If I had simply stayed invested, I'd have recovered those losses entirely.
If you've also been in this position, you're not alone. Market volatility is tough to stomach. However, withdrawing your money can not only be costly in the short term (with potential withdrawal penalties and taxes), but it can also hurt your long-term earnings potential.
While it's easier said than done, it's often best to simply ride out the storm. As long as you're investing in quality long-term stocks, your investments will very likely bounce back. So sit tight, wait it out, and (if you're like me) avoid checking your investment account balance too often when the market is in a slump.
2. Investing too conservatively
Most people have a mix of stocks and bonds in their portfolios. When I first started investing, I allocated a hefty chunk of my portfolio toward bonds, thinking that would keep my money safer. In reality, it limited my long-term earnings.
Bonds generally are safer. But because they tend to earn lower returns than stocks, they also make it much harder to build a substantial amount of wealth.
For example, say you're investing $200 per month. In scenario one, you're investing primarily in stocks with some bonds, earning an average rate of return of 8% per year. In scenario two, you're investing mostly in bonds, with an average return of around 5% per year. Here's approximately how your savings would add up over time:
| Number of Years | Total Savings: 8% Average Annual Return | Total Savings: 5% Average Annual Return |
|---|---|---|
| 20 | $110,000 | $79,000 |
| 25 | $175,000 | $115,000 |
| 30 | $272,000 | $159,000 |
| 35 | $414,000 | $217,000 |
| 40 | $622,000 | $290,000 |
Data source: Author's calculations via Investor.gov.
This isn't to say that it's always a bad idea to invest conservatively. As you near retirement age, for instance, it's wise to invest more heavily in bonds to better protect your savings against market volatility.
A common rule of thumb is to subtract your age from 110, and the result is the percentage of your portfolio to allocate to stocks. So if you're 40 years old, you may allocate around 70% of your portfolio to stocks and 30% to bonds -- adjusting those numbers, as necessary, to account for your personal risk tolerance.
3. Waiting to get started
When you're decades from retirement, it's easy to fall into the trap of thinking you have plenty of time later in life to save. But time is your most valuable resource, and getting started early will make it far easier to generate wealth.
Of course, you can't go back in time if you're off to a late start. But waiting even a few years to begin investing can have a serious impact on your long-term savings.
For example, say you're investing $200 per month while earning an 8% average annual rate of return. Here's approximately how much you could save by age 65, depending on the age at which you began investing:
| Age You Began Investing | Total Savings by Age 65 |
|---|---|
| 20 | $928,000 |
| 25 | $622,000 |
| 30 | $414,000 |
| 35 | $272,000 |
| 40 | $175,000 |
| 45 | $101,000 |
| 50 | $65,000 |
Data source: Author's calculations via Investor.gov.
It's not impossible to accumulate hundreds of thousands of dollars if you start investing later in life. However, you'll need to invest much more per month to reach your goals.
Investing isn't an exact science, and everyone's preferences and approaches may differ. But by avoiding some of the most common mistakes and regrets, it will be easier to build life-changing wealth in the stock market.
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