10-02 Ten Mistakes to Avoid
1. Over-diversification.
Sure, every expert with a pencil, computer, or microphone keeps telling you to diversify your portfolio. They are right, but they often neglect to tell you the rest. For example, assume you only have $200 to invest. You buy 40 different stocks at $5 each. Guess what? Now you’re too “thin” and you have racked up enormous trading fees that start your portfolio at a substantial loss. Even if one or two stocks skyrocket, they won’t make a real difference in your portfolio since they hold a relatively small position in your overall portfolio. 15 to 20 diversified stocks should be plenty and you can have as few as 10 if you include ETFs to keep things balanced.
2. Becoming a “Trader.”
Compile a list of the best investors in the world and you probably won’t find even one who engages in frequent day trading. Smart investing does not equal constant intra-day trading. Even if you have early success as a day trader, the odds, the tax code and the markets are all stacked against you. Like a casino “winner” at Las Vegas, the markets know that the longer you play the day trading game, the better chance you have of losing and giving back all your winnings, and then some. A “buy and hold” investor like Warren Buffet would gladly tell you that you’re crazy to adopt a trader’s strategy.
3. Disregarding “time horizons.”
Here is a simple example from the banking world. You have $1,200 to invest. You decide that, for an extra quarter percent interest, you’ll put it all in a 5-year CD. However, you need $400 in 6 months. You need to withdraw that amount and forfeit all interest earned. In one year, interest rates spike upward and your remaining 5-year CD is earning well below market rates. You’ve disregarded the investment timeline and it’s cost you money. If you are buying a car soon, or a house in a few years, or you have children that you need to send to college, you need to have a plan to make sure you have the cash available when you need it.
4. Making investment decisions based on emotions.
Your former superstar stock dropped 10 percent today and you’re in a panic. Relax and do nothing while in this state of mind. Place your laptop where it belongs. On your lap. Investigate the reasons for the decline. You might find that, instead of dumping this stock, you might want to buy more. A funny thing about Wall St. is that it’s the only place on Earth where people run away when there’s a “sale” on the product.
5. Paying too much for investment advice.
Many investors, particularly newer ones, overpay for investment services. Feeling that you need full-service brokers is understandable, but the service is usually unnecessary. First, all fees are negotiable. Second, if you’re doing your homework, you can make your own investment decisions. Third, if you’re always dependent on the investment advice of someone else, you’re never truly free and in control of your life. Learn how to invest for yourself and you’ll never have to depend upon costly investment advice!
6. Impatience that leads to paying too much for your investments.
Do you know the “key” to successful retailing, (think shoes, computers, toys or clothing)? Listen closely, it’s not how much you sell it for, rather it is what it costs you that affects profitability. You can’t predict the future to see when or how much to sell something for, but you can certainly control the cost. The same is true for investing. The selling price is much harder to predict than the purchase price. Only pay a fair price for your investments. Don’t “chase” a stock price higher and let greed get a hold of you. Remember, new investment opportunities always come around if your current one has escaped you by rising out of your price range.
7. Assuming that the future looks like the past.
This is a common mistake made by many newer and casual investors. They assume that current earnings will continue and project future earnings at the same or higher level. For example, a consistently mediocre company has a wonderful year. Investors automatically assume the company has found the “secret” to profitability. Once again, adopt a critical, independent viewpoint. Assume nothing. Do the research and learn if they’ve found the “secret” or if they were just lucky that year.
8. Unrealistic expectations.
Avoid setting unrealistic or impossible expectations for any investment. It clouds your judgment, generates bad buy/sell decisions, and erodes your confidence. Be realistic with your performance projections and see the long road of a lifetime of investing decisions.
9. Suffering paralysis by analysis.
You understand that you should be an independent investor. You do your own research, and make smart, personal evaluations. However, many newer investors spend too much time exercising their newfound skills. In fact, they love the research and debate so much that they forget to actually do it and get in the game. A fast moving market can make analysis paralysis a costly mistake. Your aim can be perfect, but if you can’t pull the trigger, you’ll never hit your target.
10. Lack of a plan or a strategy.
Becoming an investor will seldom be a successful experience if you don’t have a working plan and some type of strategy. You may as well just buy lottery tickets or visit your favorite casino (at least you might enjoy a wonderful dinner). The level of sophistication of your plan and strategy is not important. The fact that you have one is critical. A failure to plan is a plan to fail. Think about the many different investment strategies offered in this course and try one risk-free using fantasy money first on your virtual account.