How To Avoid Common Investor Mistakes
People often make financial decisions based on impulses and market shifts
In 10 seconds
Want to invest wisely? Start with why you’re saving and investing: A goal. Don’t overreact to short-term gains and losses. And keep your cost-of-living low, even when your income increases.
In 1 minute
Even savvy investors can let their impulses get the best of them. By understanding how our natural tendencies can cause poor financial decisions, we can teach ourselves to make wiser choices.
Goal-based investing means identifying what you need money for in the future, and aligning investments around a tangible outcome. Having a goal helps you decide:
- Where to invest
- How much to invest
- How long to invest
Short-term losses are part of the process. If you constantly check your portfolio’s performance and react to short-term losses, you’ll likely hold yourself back. Instead, focus on the process that can yield long-term gains, and give your investments time to grow.
“Lifestyle creep” can easily throw off your plans for the future. As your income increases, try to keep your cost of living about the same. If your regular spending increases, you’ll need to save and invest more to maintain your new lifestyle.
That’s the short version. Learn more about common investor mistakes below.
In 5 minutes
In this guide we’ll:
- Explain how biases lead to bad financial decisions
- Look at common mistakes investors make
- Show you how to avoid these investing mistakes
The source of common investor mistakes.
Investing mistakes are often rooted in our natural reactions. Let’s face it: We don’t always react the right way to information. And when enough investors have poor reactions, it can affect the entire market.
Behavioral finance is a field of study that looks at how psychology affects financial decisions. It helps us understand why investors make common mistakes, so it’s easier to avoid them. But don’t worry—it doesn’t have to be complicated. Some of the most important lessons from this field are surprisingly simple.
Try to invest with a goal in mind.
Investing is one of the smartest financial decisions you can make. But a lot of investors start without knowing what they’re working toward—and that’s, well, less smart. When you don’t know why you’re building a financial portfolio, it’s a lot harder to know things like:
- What account types to use
- How much risk to take on
- How much to invest each month
- How much you can spend without feeling guilty
- How much total money you’ll need to save
- How long you need to invest
Instead, start with why. What do you want to be able to spend money on in the future? When are you going to use that money? These aren’t just stocks and bonds. Your investment is a future downpayment on a house. Your dream car. Retirement. College. Real things and experiences you want to be able to afford.
Having a goal takes the guesswork out of investing. You can calculate exactly how much you need to invest based on the range of potential outcomes. It’s also easier to decide where to put your investments. Retiring in 40 years? Take more risk and put more in stocks. Hitting your goal next year? Play it safe.
When you know how much you need to invest, break it into monthly chunks and automate your deposits. With recurring deposits, you're basically “paying yourself first” before worrying about other expenses. That way, you won’t talk yourself into skipping a month. (Which turns into two months, then three, and—oops, it’s been a year.)
Focus on the long-term.
When you invest, you’ll have short-term losses here and there. It’s inevitable. And most times, it’s a mistake to make adjustments when your portfolio loses value. You can’t predict tomorrow’s performance based on yesterday’s.
Even during the last ten years of steady growth, investors had to endure short-term losses at some point every year. Given enough time, the market trends upwards. And investments that perform poorly one day can easily make up for it the next.
But that’s not what most people think about when they see their portfolio lose 15% of its value. They panic. They make sweeping changes, reinvesting in funds and stocks that had short-term gains. And those big emotional decisions often do more harm than good.
Investing is about long-term gains. Short-term losses are simply part of the process. Don’t panic every time there’s a loss, and you’ll likely see bigger long-term gains.
Watch out for “lifestyle creep.”
You don’t have to live frugally to be a successful investor. It helps, but the bigger issue is making sure that as your income increases, you stay in control of your lifestyle and spending. Most people see small pay increases over the course of their lives. 3% here. 8% there. When your regular spending increases with your income, it’s known as “lifestyle creep.” It can easily get in the way of saving enough to achieve your goals.
If you have a lower income, it makes sense that more of your money goes toward basic necessities. But lifestyle creep happens when you gradually spend more on things you don’t need. Entertainment. Hobbies. Take out.
Every time you increase your regular spending, your lifestyle costs more to maintain. You’ll likely need to save more for retirement. Your emergency fund may need to grow, too.
Lifestyle creep is an even bigger problem if you started investing with the expectation that you’d invest more later. Some people feel intimidated by their goals, so they plan to increase the amount they invest when they start making more money. That’s fine—as long as you actually do it.
Temporary increases in spending are OK. But as you make more money, don’t let a more extravagant lifestyle sabotage your goals.
You want to invest because you want to use your money wisely. At Betterment, we help you do that by building your portfolio around your goals and setting you up to play the long-game. Right from the start, you’ll know our suggested allocation for your portfolio, how much to invest each month, and what outcomes you can expect based on your input. Schedule recurring deposits to help you stay on track, check your progress, and make adjustments at any time.