Whenever you invest, you are taking on a certain amount of risk. There is always the chance that you could lose money. There is no way to completely get rid of investment risk. However, there are things you can do to improve the chances of seeing more gains than losses — and mistakes to avoid.
Here are 5 investing mistakes that could destroy your portfolio:
1. Heavy Reliance on Company Stock
If you invest in a tax-advantaged retirement plan offered by your company, there is a chance that you are heavily invested in company stock. You may not have read over your options carefully when signing up, or you might have accepted some stock as payment or a bonus. While some company stock isn’t a bad thing, you should be careful not to rely too heavily on a portfolio with a lot of company stock. What happens with the company goes down? Your retirement account could be severely damaged.
2. Not Enough Diversity
It’s also important to ensure that you have enough diversity in your portfolio. Anytime you rely too heavily on one type of investment, you add extra risk to your portfolio. Too much diversity can dilute the effectiveness of your portfolio. But you you should consider diversity across sectors and asset classes, as well as geographic location. Consider your own investing goals and choose a mix that is appropriate for you.
3. Not Understanding Your Risk Tolerance
You should know yourself and your investing needs. You should be aware of your risk tolerance. This is how much risk you can bear, in terms of your financial situation and your emotional ability to handle the realities of the market. You have to understand your risk tolerance in order to make better decisions about your investments. Know what you can afford to lose, and recognize when your emotions are getting in the way of better decisions.
4. Refusing to Change Your Position
Sometimes, it’s time to make changes to your portfolio. When you have a more passive investing strategy — along the lines of buy and hold or investing for retirement — this might take the form of rebalancing at regular intervals. In more active strategies, you might need to cut your losses and sell a loser. Or, you might have a winner that keeps climbing and climbing in a short period of time. It might be wise to take profits while you still have that chance, rather than trying to run up bigger profits. It’s important to re-assess the contents of your portfolio regularly, and consider making changes as appropriate.
5. Investing in Something You Don’t Understand
Warren Buffett famously suggested that you should understand what you’re investing in. Before you add something to your portfolio, you should understand how it works. Stocks, bonds, funds, commodities, real estate, currencies and other investments are traded in different ways, and are affected by different economic conditions and market perceptions. One of the reasons we ended up with such a disaster in 2008 was due to complex financial instruments that few people understood when they were investing in them. Learn about what you are investing in, know where to research investments, and how it might affect your portfolio.
Tom Drake is the owner and head writer at Canadian Finance Blog, covering everything from universal topics like budgeting and investing to Canadian topics like RRSPs and the the TFSA.
Last Edited: 6th March 2012