At our most vulnerable times a little devil appears on our shoulder, whispering unsavoury advice into our ears. Without much thought, we disregard our investing principles and blindly follow our gut, causing us to fall victim to the seven deadly sins of investing.
In the following weeks, we’ll be discussing the seven deadly sins of investing in the stock market. We’ll have a look at why these seven investment acts are regarded as sins and, more importantly, how you can avoid these costly mistakes.
Sin #1: Lust
Lust or temptation presents itself in the form of short-term investment opportunities or “get-rich-quick” schemes.
We all invest to grow our wealth, but some people expect to see results sooner than others. With the fast pace way of the world, people generally seek instant gratification. Most investors don’t want to wait around to only see a substantial return on investment after a minimum of three years. They want results straight away.
Results in the short-term may be quick, but it’s not nearly as attractive as the returns gained over the long-term. There are multiple reasons why you should follow a long-term investment approach rather than a short-term one.
Why you should avoid short-term investing
Seeking short-term opportunities requires investors to time the market.
If you’re lucky, you might time the market perfectly once or twice, but the other 98 or 99 times you won’t be so fortunate and quite possibly lose far more than what you previously gained. The level of risk accompanied with short-term investing is tremendously higher, because you invest according to trends and patterns rather than value.
Short-term investors tend to jump on the bandwagon and buy into “the flavour of the month” stocks. The problem with this strategy is that by the time you find the next trending stock, the opportunity for making a profit has usually already passed. Which means you’re simply buying an overpriced stock, hoping to sell it at a higher share price. You have no guarantee that the price will rise. And if it does rise, you sit with your fingers crossed, hoping it appreciates enough to cover the transactional costs and taxes of your trade. If it doesn’t, you make a loss.
Another disadvantage is that short-term investors don’t benefit from any special tax rate and have to pay higher tax rates than long-term investors. According to TurboTax, in the U.S., short-term capital gains are taxed at the same rate as your ordinary income, which can be anything from 10 percent to 39.6 percent, depending on your total taxable income.
The benefits of value investing
A long-term investment approach has multiple benefits. But let’s look at the most evident ones.
No financial degree required
The principles of value investing are straightforward. You buy undervalued stocks with an economic moat at a margin of safety and hold onto those stocks for a long time.
Value investing choices are made purely on fundamental analysis and therefore devoid of emotion - reducing, if not eliminating risk. Investing with a margin of safety also leaves room for you to correct any investment mistakes you might have made.
By keeping your stocks in the market for longer than a year, you qualify for a reduced tax rate on your profits. Even better, for as long as you stay in the market, you pay zero fees and taxes.
If you take a historical view of the markets, you’ll notice that globally markets have grown over the long-term. The results of long-term investing are phenomenal. Well-known value investing guru, Warren Buffett, turned US$6K into US$70 billion by investing over the long-term. Although it took him years and a lot of patience, he is now sitting on a mountain of wealth. Value investors take full advantage of compounding interest making it a powerful investment strategy.
Unfortunately, there is no effective, low-risk way to “get-rich-quick” investing in the stock market. But you can generate tremendous wealth if you invest patiently. Resist the temptation of short-term investments and keep your sights set on the horizon.
Hat tip to Aberdeen Asset Management for the inspiration behind this series.