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6 investing mistakes novices make

Young adults with steady incomes should be setting some aside for retirement -- but that can be a whole lot harder than it sounds. Here's how to avoid the common missteps.

[Related content: 401k, bonds, investments, mutual funds, stocks]
By U.S. News & World Report

Do you think you need to have "extra" money before saving for retirement? Or that you'd rather invest in specific companies instead of broad index funds?

Those are just two common mistakes that young people make when they start thinking about putting money into the stock market.

Here are six common errors, and how to avoid them:

1. Getting excited about single stocks. When J.D. Roth, the blogger behind popular personal finance site Get Rich Slowly, started investing, he put a year's worth of Roth IRA (it is named after the late Sen. William Roth of Delaware) contributions -- about $3,500 -- in Sharper Image stock. A friend who worked at electronics and gadgets store The Sharper Image had recently mentioned that he invested in the company himself, which made Roth think the shares were undervalued. Unfortunately, that was in 2007, shortly before The Sharper Image filed for bankruptcy.

Investing in your favorite company may seem more glamorous than putting money into an index fund that reflects a broad segment of the market, but it's a far riskier choice, because single companies can suddenly go under or plunge in value.

Aside from being diversified, index funds carry the added benefit of having low fees because they're passively managed, which means they don't rely on a person to research and select stocks. Today, Roth puts his money in index funds, including bond, stock and real-estate funds.

2. Thinking investing is for rich people. Waiting until you have "extra" money to invest probably means you'll be waiting forever.

Instead, consider starting by contributing small amounts to your retirement account and slowly raising the percentage.

3. Forgetting to check up on expenses. Expenses can take a big chunk out of your investment return. But fees vary widely, typically from 0.1% to 2% of your total investment on an annual basis.

The Rand think tank found that when people were presented with various fund options, including one that clearly came with the lowest fees, only half selected that lowest-fee fund. One in three people inexplicably selected the fund with the highest fees. (All of the funds exhibited equivalent returns.)

And that's another reason to invest in index funds instead of more tailored mutual funds: Because fees automatically reduce investor returns, they are a primary reason research suggests that passively managed index funds perform better for investors than do actively managed mutual funds.

4. Keeping close track of the market's highs and lows. If your investment portfolio is well diversified and you check in on it once every few months to see if it needs to be rebalanced, there's no need to follow daily fluctuations.

Instead of keeping an eye on the cable news channels, which can make every dip feel like a crash, focus on your hobbies, relationships and other sources of stability. If you still feel anxious about the market's movements, maybe your investments are too risky and you'd be better off putting a greater percentage of your portfolio into relatively safe (and lower-yielding) money market funds.

5. Failing to diversify. Diversification -- in market sectors, industries and specific companies -- reduces your chances of losing everything. One of the easiest ways to do that while investing in the stock market is through index funds, which mirror a specific market index, such as the Standard & Poor's 500 Index ($INX).

Most of the victims of the Bernie Madoff scam suffered particularly bad fates because they entrusted their entire nest eggs to a man who turned out to be orchestrating a Ponzi scheme (in which early investors are paid from new investors' money, not from any actual earnings).

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6. Letting an adviser -- or your parents -- invest for you. There's only one way to learn, and it's by making mistakes, as Roth did. If you enjoy checking up on your accounts regularly and plugging numbers into spreadsheets, you can probably manage your own money.

Some people prefer to rely on professionals, and that's also fine, as long as you still play an active role. Most good advisers recommend understanding exactly where you're putting your money and not just trusting someone to make the right decisions for you.

This article was reported by Kimberly Palmer for U.S. News & World Report.

Published Nov. 10, 2010

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10Comments
12/27/2010 5:32 AM
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You left out the most important  TWO points that are NO NOs:

 

1~ Believing a companies financial reports

 

2~  Trusting this website or Jim Cramer

 

harrumph

12/05/2010 10:29 PM
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I would mostly agree.  Lower risk.  I am fairly diversified now, but last year, I bought huge amounts of shares, in only a couple companies.  I knew the market was undervalued, and individual stocks where at bargain prices.  This cycle happens regularly, (look at the past 10 years) probably not as dramatic as last year, but as intelligent investors, we need to take advantage of these unique opportunities, when they come around.  Investing involves being nimble, knowing how to shift your investment approach.  It is the key to making big gains in this venue.  IMO.
11/11/2010 4:20 PM
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I've done few of these mistakes myself. I learned from them and on my way of creating wealth. Good article!
11/11/2010 3:32 PM
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Wall street has become nothing more than a Casino...corporations like fat sacks use supercomputers to get the advantage over every trade made by the average joe from a desktop. It's all who controls the information-and it sure isn't us. Imagine you see a stock topped out where you wanted it so you hit the sell button along with several other sellers-fat sacks WOPR see's this and in a split second, sells it's shares while the "system" is still grunting processing your order-so you either got less or your sell order didn't go thru because the price dropped out of your limit....and fat sacks get fatter.

Stocks rise or drop excessively because of what the news says, not based on the actual financial strength of the company. The house always wins and that's why it's there.

With QE2 and path this nation is headed down, I will invest in nothing I can't walk on ,live in, drive, or hold in my hands.

 

11/11/2010 1:54 PM
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The problem isn't investing in single stocks. It's getting excited about them, making quick judgements with absolutely no homework, no fundamental analysis.

 

"A friend who worked at electronics and gadgets store The Sharper Image had recently mentioned that he invested in the company himself, which made Roth think the shares were undervalued."

 

Really? Really? That's it? That's his analysis. People like this not only will fail in investing, but deserve to fail in investing. Single stocks are not the problem. Proper fundamental analysis will tell you for sure whether a stock is undervalued or not.

 

So instead of solving the real problem of actually not doing your investment homework, the author points people in the direction of diversification?!? Pathetic.

11/11/2010 12:46 PM
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Sounds like typical buy & mold philosophy. Check your positions every few months? That may work if you can contribute significant amounts to your retirement but most people can't. ETF's are, by definition, yield average (ie mediocre) returns because they are not managed. Mutual funds are actively managed & generally produce superior returns to ETF's. The best solution is to pick your own positions (stocks, bonds, mutual funds, ETF's, etc) through an on line discount brokerage. However, fundamental & technical education and paper trading should be engaged in before live investing. Learn to swim before you jump in the water. Active investing is a part-time job/hobby.

If you fear loss of funds, buy into conservative mutual funds when the general market has had a substantial pullback & is beginning to recover. Go online & check the prospectus of each mutual fund to determine how long you are required to hold the shares. When the market declines again, sell your mutual funds & hold the cash in your brokerage account until the market begins to turn up again. For active investing (not day trading) use Investor's Business Daily IBD100 published each non-holiday Monday. Never buy & mold.

11/11/2010 10:06 AM
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simply not putting in as much as you truly can in the early days is a sad pay off in 40 years
11/11/2010 12:02 AM
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Not bad advice,  I would recommend when investing in single stocks to look a the companies/stocks you own weekly and not every few months.   There can be big swings in the market prices....  

You should manage YOUR MONEY!! not any one else.  With that said it is important to seek good advice from people that you trust, be it a stock broker or friend ....
11/10/2010 10:34 PM
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