“I remember a friend telling me how he made over $20,000 from his Tesla stocks on August 25 – the wildest day of the rally. The FOMO at the time was palpable.”
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When investors lose money, we often think it’s down to their poor asset choices. As you’ll soon find out, investing in quality assets may not be enough to prevent those pesky losses.
Imagine this:
You believe investing can accelerate your journey to financial freedom; so, you decide to give it a shot.
You do your research, choose a promising market and decide to buy shares in a company with rock-solid fundamentals.
But you realise that individual stocks can be risky, so, to play it safe, you opt for an index fund instead.
Nothing can go wrong from here, you think. But something strange keeps happening. You find yourself stuck in a loop of losses, like Bill Murray in Groundhog Day.
Despite the fund you’ve invested in growing in value over time, for some reason, you’ve lost money in the same period!
What? How could that have possibly happened?
Well, it turns out, you’re being haunted by the ghosts of your pre-investment decisions.
In spite of your meticulousness in choosing a quality asset, you’ve put the cart before the horse, sabotaging your movement towards your investment goals.
Thankfully, it’s never too late to make amends. And if you’re just starting your investment journey, it’s even better.
Here are four pre-investment decisions that might be causing you to lose money in the stock market.
1. Entering without a game plan
The first time I heard the saying, “he who fails to plan is planning to fail,” I thought, “who in their right mind would plan to fail?”
But I quickly realised how often we do things without a plan, even the things we care about.
This is a dangerous approach to investing. It’s crucial to create a plan before embarking on your investment journey and stick to it.
Without a plan, you’re likely to succumb to the recklessness of YOLO and FOMO, or fall prey to sensationalised FUD headlines that typically lead to poor investment decisions.
Having a plan brings clarity of purpose and reduces the chances of reactive investing, especially during times of heart-pounding market volatility.
Some of the questions you might want to answer in your investment plan are:
- What’s my investment goal?
- What’s my timeframe?
- How will I achieve them?
- How much can I afford to invest and how often?
- Do I want to invest in individual stocks, funds or both?
- What criteria will I use for selecting individual stocks to invest in?
- What’s my risk tolerance?
- What do I do in different market conditions – bull or bear market?
- Other questions relevant to your unique situation
While having a plan is essential, it might not be enough to stop you from racking up preventable losses, especially if you face the consequences of the next decision.
2. Entering with a baggage
There’s a reason why people toss aside whatever they’re holding when fleeing from danger. Some even kick off their shoes, so they can run faster.
But seriously, you’re as fast as the baggage you’re carrying would allow you. The less you carry, the higher you can fly.
Every debt you take on reduces your disposable income, which would have gone towards investing, since it must be paid back with future paychecks.
While no one expects you to pay off your mortgage or student loan overnight, the typical culprits are your high-interest rate loans, such as credit cards.
With an interest rate of 21% or more, you’re looking at an interest cost higher than the typical market return of 9%.
So, if you choose to invest without first settling these types of loans, you’re likely to encounter these scenarios:
Firstly, even if you achieve the typical market return, you’ll still end up with a net loss of 12%.
Secondly, the interest cost on your debt is guaranteed, but your investment return is not.
In fact, your investments might even yield a loss, in addition to the borrowing cost. This means you’re losing money on both fronts.
Thirdly, you might eventually realise your mistake and decide to reverse course by liquidating your assets to pay off your credit card debt.
The problem here is, at this point, you might be selling at a loss.
In a nutshell, before embarking on your investment journey, shed the baggage of high-interest loans.
3. Investing without a cushion
Apple is known for many things: the most valuable brand in the world, the business with the largest market capitalisation and a company that makes you feel good paying a lot of money for its products.
One thing that’s not talked about often is that Apple has tens of billions of dollars in equity capital and reserves.
That’s a huge reason why businesses with such strong financial footing are able to weather the storm during periods of economic downturn, while those without a financial cushion go under.
The same principle applies to personal finance and the importance of an emergency fund.
Interestingly, when we think of an emergency fund, what usually comes to mind is taking care of our urgent financial needs.
But if you’re an investor, your emergency fund does more than that. It can also prevent your hard earned money from going down the drain.
Imagine facing an urgent financial need without an emergency fund. Your first instinct might be to reach for your credit card.
As we discussed earlier, this has some consequences, particularly, if you don’t clear the balance on time.
But that’s not all. What if you have no access to credit? Then you might be forced to liquidate part or all of your investments, and that’s when things can get tricky.
I’m sure you know the drill by now. What happens when you have to sell your investments at a loss?
As you can see, an emergency fund is not just a cushion for unexpected expenses; it can also protect your investments.
4. Trying to make a quick profit
On Thursday, November 4, 2021, TSLA reached an all-time high price of $409.97. On the same day, VOO was just 1.7% below its highest price to date.
By that day, the electric vehicle manufacturer’s stock had surged by almost 110% since May 21, 2021.
I remember a friend telling me how he made over $20,000 from his Tesla stocks on August 25 – the wildest day of the rally. The FOMO at the time was palpable.
While we all know how the story has unfolded since then, the reality is, this wasn’t the sentiment at the time. You would think the price would keep going up, at least, for the foreseeable future.
So, it’s understandable why anyone would have been tempted to get in on the action.
But this is the trap many investors fall into – trying to make a quick profit, especially by investing the money they need in the short term.
If you invested $50,000 at the peak price on the 4th, in just six weeks you would have lost 24% of your investment.
But if you decide to ride it out, God help you if you had an urgent need for your money on January 6 2023, when the stock price had fallen by 72%.
That means in just over a year, you would have lost a staggering $36,000!
Can TSLA reach a new all time high? Absolutely. But when? Nobody knows.
The point is, if you don’t want to get caught up in a sell off or a prolonged bear market, don’t invest the money you need in the short term.
Final thought
Investing is not all about choosing the right assets, your choices before you even start can determine your financial fate.
These choices can haunt you in different ways. They can force you to make decisions you know would hurt your finances, like selling your investments at a loss.
Don’t let your pre-investment decisions sabotage your financial goals, consider doing the following:
- Do your research, write a clear plan and stick to it
- Get rid of your high interest rate loans
- Have a healthy financial cushion, and
- Avoid investing the money you need in the short term.
Some investment losses are avoidable, if you build a solid foundation before investing your hard earned money.
