Investing may seem like a fairly simple undertaking – buy low and sell high. Unfortunately, the reality of investing often proves a bit more difficult than it seems from an outside perspective.
New investors typically take one of two approaches to the stock market. Either they intend to buy and hold a diverse group of stocks for the long term, or they plan on buying and selling individual stocks in an attempt to beat the market in the short term.
Active trading isn’t as easy as it looks. Unfortunately, inexperienced investors often overestimate their ability to time the market. In fact, this novice overconfidence is so prevalent there is actually a specific name for it – the Dunning-Kruger effect. In layman’s terms, novices are often so bad at something that they are unaware of how bad they are.
New investors open up trading accounts and wholeheartedly believe they can generate huge returns by actively trading. Ironically, these traders tend to compound their poor trades by overtrading, which simply piles commission fees on top of market losses.
Stubborn traders may take years to get enough of a feel for how the market works to make consistently profitable trades. Others may take years to learn that they are simply no good at timing the market and should stick to passive investing. Either way, those years of learning are critical. People who begin investing for retirement at age 45 can’t afford to spend six or seven years losing money before they get a feel for the market. However, investors who pay their dues when they’re in their 20s can have a leg up on the market by the time they’re 30 years old.
Passive investing has its challenges. Even investors who simply plan to buy and hold are not immune to the learning curve. New traders can easily underestimate the emotional toll investing can take and the pressure an investor can feel when he or she watches thousands of dollars of life savings disappear.
From the market peak in 2007 to the market bottom in 2009, the Standard & Poor’s 500 index declined more than 57 percent. “Buy and hold” sounds like a great idea, but it can be easier said than done when more than half of your retirement savings go down the drain in a matter of months.
Investors who haven’t experienced the emotional roller coaster of the stock market often try to stay patient for as long as they can before finally selling out of desperation at the worst possible time. In hindsight, 2008 may have been the buying opportunity of a lifetime. Unfortunately, according to Morgan Stanley, panicked retail investors sold roughly seven times more stocks in 2008 than any other year from 2000 to 2012.
Time is on your side. A 25-year-old with $10,000 in savings can afford to learn a costly lesson in market emotions by losing $5,000 during a recession. A 48-year-old with $100,000 might not be able to recover from a $50,000 lesson.
“As a young person, you still have a lifetime to earn back any money you lose,” says Nicholas Colas, chief market strategist for Convergex Group. “Later in life, that runway is shorter, and a mistake may mean putting off retirement or downgrading your expectations for what kind of lifestyle you can afford in your golden years.”
JJ Kinahan, managing director of client advocacy and market structure for TD Ameritrade, says young investors enjoy other advantages over older investors, as well.
“When you are younger, you can take a few more chances that can offer a higher return with higher risk,” Kinahan says. “The nice thing is that you have time to make up for any losses which you may incur.”
The advantages of youth. It may seem like young investors who have only a modest amount of money to invest are at a disadvantage compared to older investors with much larger savings. However, Ritholtz Wealth Management portfolio manager Ben Carlson says that youth is an advantage in itself.
“Young investors have little size in their portfolio value but plenty of size in their time horizon to compound their savings,” Carlson says. “As you age, those variables will flip and investors approaching retirement will have size in their portfolio (hopefully) but not nearly as much size in their time horizon.”
New investors shouldn’t expect to start off being market savvy any more than someone who has never picked up a golf club before should expect to go out and shoot a round under par. The experts say new investors always tend to make the same mistakes when they are starting out.
Patience, discipline and emotional control are all elements that are necessary for long-term investing success. Unfortunately, learning these skills can be…
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