Originally Posted on 2017–11–30 at Fast Invest Blog
There are two ways to avoid the most common investment mistakes: the smart way and the expensive way. The smart way is to learn from other people’s mistakes; the expensive way is to pay for your mistakes from your own pocket. If you’re no fan of the school of hard knocks, then you might enjoy this succinct list of famous investment blunders and frequent mistakes that you should avoid.
The Three Major Financial Bubbles In History
History has shown that investors who lose cool heads find themselves in hot waters sooner or later.
The Tulip Bubble
The “tulipmania” that gripped 17th-century Holland is the first and perhaps the most prominent example of a speculative bubble in our history. It only lasted for four years, but when it came crashing down, hundreds of speculators were left penniless. The tulip was imported from Turkey and immediately mesmerised all flower lovers, which has led to it becoming a major status symbol for the elites. Spurring the demand even further, a great virus has caused the supply to collapse. As the supply diminished, the price of a tulip bulb rocketed.
The market reached its peak in 1637. People mortgaged their homes to buy the bulbs for resale at higher prices. According to Charles Mackay’s famous book ”Extraordinary Popular Delusions and the Madness of Crowds”, the following items were paid in exchange for one tulip root: two lasts of wheat, four lasts of rye, four fat oxen, eight fat swine, twelve fat sheep, two hogsheads of wine, four tuns of beer, two tons of butter, one thousand lbs. of cheese, a complete bed, a suit of clothes, a silver drinking cup. At that time, the average price of a single flower exceeded the annual income of a skilled worker.
The market crashed unexpectedly, causing a domino effect of progressively lower and lower prices. Everyone tried to sell as fast as they could to cut the losses, but no one emerged unscathed. Even the people who managed to sell early suffered under the following depression.
The South Sea Bubble
The South Sea Bubble is another classic example of a financial bubble. Formed in 1711, the South Sea Company was promised a monopoly by the British government on all trade with the Spanish colonies. Investors, hoping for the same kind of miraculous success as the East India Company trading with India had achieved, snapped up the shares of the South Sea Company. Shares surged 10x, and the company took advantage of the hysteria, issuing more and more shares to satisfy the insatiable demand. It got to such a ridiculous level that the company launched an investment venture with the following description: “For carrying-on an undertaking of great advantage but no-one to know what it is!” Soon after that, it all came tumbling down, and hundreds were left fortuneless.
The Dot-com Bubble
Also known as the NASDAQ bubble, the tech bubble or the internet bubble, the dot-com bubble of the ’90s triggered a massive wave of speculation that resulted in hundreds of dot-com companies achieving multi-billion dollar valuations through IPOs. Investors went off the rails, snapping up the shares in and all “internet” companies they could get their hands on. According to HSBC Holdings, the world’s largest bank, new tech companies at that time were overvalued by as much as 40%. The NASDAQ Composite, home to most of these tech companies, peaked to a level of over 5000 in March 2000. By that time, IPOs were happening on a nearly daily basis. The index crashed around that time, dropping by almost 80% and provoking a US recession. Stunningly, a whopping $5 trillion of value was wiped out in the bubble’s aftermath.
What Have We Learned From These Financial Bubbles?
#1 Do not overlook investment fundamentals. In other words, don’t trust the buzz, follow the money. While investing in business ventures that attract tonnes of attention can be a profitable short-term strategy, it’s never a good idea to invest long-term in companies that don’t have a strong revenue source.
#2 Do not get enthralled with too much speculation. Speculative investments can be very dangerous, as all you have to go by is the market’s (often) overly optimistic belief that the investment will yield great returns in the future. If the company’s yearly profits don’t correlate with its valuation, it is a bubbly venture. Look at real numbers instead of relying solely on the hopes of what might happen.
#3 Stay away from companies with a wobbly business model. A company that hasn’t figured out how to generate revenue or is struggling to turn a profit is certainly a no-go for a savvy investor. A sound business model should be one of the top criteria on your checklist.
#4 Do not ignore the business fundamentals. A great idea is not enough for a company to be successful. Examining the most important financial variables, such as the company’s debt, profit margin, dividend payouts, and sales forecasts can help you determine whether it’s worth investing in a business venture.
Deadly Investor Mistakes
Like with any other undertaking, investment skills are honed through experience. But instead of learning from your own mistakes, you could take advice from those who’ve been there and done that. Here’s what seasoned investors say was their worst mistake.
Not devising a plan
Having no plan leaves you vulnerable to emotional triggers and panic decisions. And as the old saying goes, if you don’t know where you’re going, any road will take you there. To remain grounded and adhere to a sound long-term investment strategy even when the market conditions are unsettling, you need to have a personal investment plan that addresses the following aspects:
- your investment goals and objectives;
- your risk appetite;
- the benchmarks you will use to assess the performance of your investment portfolio;
- asset allocation;
- Portfolio diversification.
The exhilaration of trying to beat the markets is fun and often empowering, but it is unlikely to be a profitable long-term solution.
Not diversifying your portfolio
The point of diversification is to help you manage the risks that can hurt your portfolio. However, it is only valuable if the new asset added to the portfolio has a different risk profile. For example, adding another P2P consumer loan from the same market or category to your P2P investment portfolio can cause your investment performance to replicate the averages. Looking from a more high-level perspective, it is smarter to add an independent and even an opposing source of return to your portfolio than to load it with more assets with a similar risk profile. Never put all your eggs in one basket and never spread them across so many baskets that your investment returns become average.
Not investing in your financial education
The best investment you can make is investing in yourself; it will pay you dividends for a lifetime. Investing is an ever-evolving, complicated process that requires knowledge, vision and intuition. Although we claim to be rational decision makers, we are emotional human beings affected by our moods, values, crowd psychology, past experiences, fear, and greed. Investing is also a science because to succeed, you must understand and apply scientific principles like diversification, asset allocation, valuation, correlation, probability, and much more.
Staying ahead of the market and studying the emerging vehicles for investment is also critical. For example, the latest investment boom in cryptocurrencies has left many experienced investors scratching their heads and missing out on colossal returns. It’s normal to fear what we don’t know, but no successful investor can afford to miss an opportunity of that magnitude for their lack of knowledge.
Here at Fast Invest, we are hoping to bridge the gap between traditional investment routes and crypto market by expanding our platform’s infrastructure on the decentralized Ethereum blockchain technology. Download our whitepaperto learn more about how we will help investors enter the cryptocurrency market and manage their crypto-wealth.
Trusting the “experts” too much
You should never trust anyone more than you trust your own research and due diligence. There are many honest, knowledgeable investment advisors who are doing the best they can with the knowledge and information they have, but that doesn’t mean they know what the future holds. Investing is a gamble, no matter where on the risk scale your assets are. It’s always best to operate from the assumption that the investment advice you receive is biased (because everyone is biased). You are the only person who doesn’t have a conflict of interest with your wealth.
Not having discipline
Not many traits can benefit an investor as much as good temperament does. To succeed in the long-run, you must be able to tune out the noise and hop off the emotional roller coaster. So don’t go chasing the crowd and changing the direction of your investment strategy every time a new fad comes along. Build resistance to the emotional triggers and don’t try to time the market — you are an investor, not a Wall Street trader.
Why Shouldn’t You Fear Failure?
The thought of failing induces fear in many of us. It is sometimes so strong that it puts us off from even trying. But letting fear get the best of us can have crippling effects in the long-run. It may hinder our ability to learn, to be present and to give it our best effort. And in the case of investing, it curbs our potential to amass wealth over time. The secret to successful investing is not higher IQ or financial education; it is usually self-control. Procrastinating on your decision to invest is costing you money every day.