DIY investing: How to avoid common mistakes and achieve success
From TikTok trading tips to “meme stocks” and a Redditor-fuelled roller-coaster ride on GameStop, social media has made DIY investing look like fun and games lately — at least until it’s “game over” with an investor’s real money.
While online platforms and apps make it easier than ever to buy and sell securities on your own — Canadians opened 2.3 million trading accounts in 2020 — DIY investors can fall prey to common mistakes that increase risk, cause stress and see them falling short of their financial goals. That can have real consequences for investors, like not being able to send their children to post-secondary school, or having to delay retirement.
DIY investors can continue to do their own investing but also seek professional advice. Decide what kind of DIY investor you are. Whichever route you choose, the following can help you avoid common DIY investing mistakes.
Start with a plan, and refer to it often
One of the most common DIY investing mistakes is diving right in without a plan. Many successful DIY investors set ground rules based on their short- and long-term goals, risk tolerance and investment time horizon. This plan guides their decisions on suitable investments, helps them determine asset allocation, and sets expectations for the rate of return. If they start to second-guess their investment decisions, they refer to the plan.
As a physician, one crucial part of your financial plan may be to adequately fund your retirement, since you can’t count on a pension. For instance, you might decide that a 6% return, over time, is required for you to retire comfortably by a set date. In that case, your plan’s ground rules might steer you clear of speculative investments that could earn 20% or more, but also present the risk of losing it all.
Maybe you’re also interested in investing “fun” money in a separate portfolio as a hobby. Your ground rules for these funds may allow more risk to chase higher potential returns inside your DIY portfolio, while having the money you need to meet your personal goals managed professionally in another.
Distinguish between trading and investing
By definition, day trading or swing trading means constantly monitoring what’s happening in the markets, so you can take advantage of price fluctuations, momentum and trends. It can be costly to miss out on an opportunity while you’re seeing patients, in the OR, catching up on sleep or trying to squeeze in quality time with your family. In contrast, long-term investing calls for trades that may stay open for longer periods, often years, in a buy-and-hold strategy.
Unless you have time to study the markets or tend toward a handful of carefully chosen stocks, you may want to consider all-in-one investments, such as investment portfolios that are regularly rebalanced and actively managed.
Be cautious about what you don’t know
Novice DIY investors can get swept up in the hype of an investment or a strategy without knowing its associated risks — or even understanding how it works.
One common error is to invest in a company’s stock without fully comprehending its business model or what’s driving its price. A popular example is Tesla. Its story is alluring, but can its valuation be justified? At its height in late 2020, Tesla had a market capitalization of nearly US$700 billion and a price-to-earnings (PE) ratio of nearly 1100 times (this meant investors were willing to pay $1,100 for every $1 the company actually earned). It sold approximately 500,000 vehicles in 2020. In comparison, Toyota had a market capitalization of US$208 billion, a PE ratio of nine times and it sold over 9.5 million vehicles in 2020. Did the future potential of Tesla warrant the premium or was this FOMO at work?
It’s even tougher to grasp the inner workings of high-flying investments like Bitcoin and cryptocurrencies that some would argue have become a speculative asset class all of their own.
Do your homework, but don’t be swayed by all the chatter in online forums touting complex trading products and strategies without really knowing if they may be right for your individual circumstances.
Check sources, and be skeptical
Today’s investment tips spread as fast as memes, fake news and celebrity gossip do. Popular social media sites, Facebook groups and videos on YouTube and TikTok are all unregulated sources of financial and investment advice and may contain inaccurate or misleading information about companies and services.
As the GameStop story revealed, social networks may even facilitate a deliberate attempt to manipulate markets, which is illegal. There is no shortage of self-described money gurus or investment “influencers” keen to promote a product, investment or idea, without any regard for your personal situation, financial plans or financial future.
While your online brokerage can’t recommend what to buy and sell, you can use its resources to help you make more informed decisions.
Use credit wisely, if at all
One of the most costly pitfalls of DIY investing is becoming overextended using margin or credit. While borrowing to invest may look like an easy way to boost potential returns, it also involves more risk than using cash, since losses are magnified and margin can be called at any time.
Given physicians’ easy access to a large line of credit at a low rate, you may be tempted to borrow to purchase investments. In certain situations, borrowing to invest can make sense, and the interest expense may even generate tax deductions on investment income. But be aware that the tax treatment of investments can be quite complex when using borrowed money. There are many factors that affect whether the interest is tax deductible, including the intended use stated when you acquired the loan.
Using credit to buy investments could have unintended consequences, and you could end up paying more than the potential returns you are seeking. Be sure that you understand the potential advantages and risks, or seek a professional opinion, before using this speculative strategy.
Keep emotions in check
You may find the inevitable ups and downs of volatile markets hard to take while investing on your own. Human nature can derail rational investment decisions, and you may find yourself driven by fear or greed. Some of the most common and costly errors are to buy high and sell low, ignore diversification and act on unreasonable expectations.
Disciplined investors stay in control by avoiding emotional investing. If you’re gripped by uncertainty, it may be the right time for you to seek professional advice.
Invest to advance all your best interests
As you gain confidence as a DIY investor, keep in mind that there’s more to financial health than just the securities you buy and sell. The financial planning process — the path from where you are now to where you want to be — guides the investment strategy for funding each personal goal, from expanding a practice and providing for your family to planning your next chapter.
MD Financial Management (MD) can provide as much guidance as you need, from professional investment services to financial planning advice that spans asset management, financial management, risk management, tax planning, and retirement and estate planning.
Contact an MD Advisor* to learn more about creating your own personalized approach to investing that can integrate self-directed accounts and advisor-supported service, if and when you need it.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals.