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Admit it . . . you're not perfect. Still, it would be nice to learn from someone else's mistakes for a change, or at least avoid making the same mistakes twice. With that in mind, here are 10 of the most common mistakes made by astute (and some not-so-astute) investors. Feel free to tally up how many you've made. If you tick off fewer than two, consider yourself a pro; three to five, you're an expert; six to eight, you need some help; more than eight, don't just sit there . . . rethink your actions! Read on to see how you fare.
1. Love me, love my stock. Everyone's heard the one about the stock inherited from grandma that began as a few measly shares and, through dividend reinvestment (and divine neglect), is now worth hundreds of thousands of dollars. The stock shares are like the Energizer bunny . . . they just keep going and going, and presumably they always will. Or will they?
Whether you're holding shares of a tobacco company, a soft-drink purveyor or a software developer, perhaps you should consider selling off a few of those wonderful shares and diversifying your portfolio a bit. (Before you do, however, be sure to check with your tax advisor.)
2. Hot fund, cold fund, 1, 2, 3. If you're seeking a few good funds and have set your sights on a few of last year's hottest ones, look before you leap. In many cases, last year's top performers will be funds of similar style and market sector, which means they'll probably all move in the same direction--not bad if that direction continues to be up, but no fun if things go the other way. That old saying, "Past performance is no indication of future returns," is especially meaningful here, as the performance of investments over time shows a regression toward the mean. A hot fund could cool off just as you're getting into it.
Instead, consider looking for fund managers with good long-term track records whose funds are out of favor and who aren't winning any popularity contests. By selecting funds that are out of sync with the current best and brightest, you'll have the chance to get in early on a trend. Of course, you may get in too early, as did many investors who bought international funds in 1997. While their investments underperformed investing in large U.S. companies last year, 1998 has gotten off to a great start for these funds; many are currently outperforming many U.S. large-cap stock funds.
3. Going for broke. Buy low, sell high. How difficult can that be? For many of us, it's almost impossible. It seems that lots of folks can tell you when to buy a stock (your brother-in-law, your golf buddy, even your broker), but few can tell you when to sell. See if this sounds familiar: You buy shares in a stock you like and the price begins to rise. It continues to rise until you have a profit of more than 20 percent. You're now faced with a classic dilemma: Do you take the profit and run? Unfortunately, no one has a crystal ball. You may have a pharmaceutical company with the cure for cancer on your hands, but there's no way to know for sure.
One possible strategy? When buying, set a target price at which you'd be happy to sell. When your shares get there, reevaluate your decision to see if you'd buy the stock anew at the higher price. If not, sell, sell, sell, and don't look back . . . unless the price falls to a point where you want to pick it up again.
4. Better safe than sorry? Recently, a new client came in to see me. About to retire, he wanted to be sure he could maintain his lifestyle with his current investments. As he pulled out his retirement plan statement, his whole demeanor changed. "I can't believe I left all this money in a money market fund for the past six years," he said. "I could have done so much better if only I had invested a little of it in the stock market. I was just so afraid of losing it that I didn't do anything."
Certainly, this investor was justified in his fear of stock market fluctuations. There's always some measure of risk when investing in stocks and a chance you'll lose money. Unfortunately, however, thanks to the bite taken by inflation and taxes, you can also lose purchasing power in money market funds and other similar investments. Our investor didn't realize his money market fund was neither insured nor guaranteed by the U.S. government. Further, there's no assurance such a fund will maintain a stable net asset value of $1.
The moral of the story? To retire in the style to which he's accustomed, our investor may be forced to work longer or to invest more aggressively than he might have had he included a partial investment in stocks in his portfolio from the start.
5. Over there . . . I think. Looking to diversify your portfolio into overseas markets? Many financial professionals agree that investors can improve the long-term performance potential of their portfolios by moving between 10 percent and 30 percent of their money into foreign investments. But is your fund truly invested across the water? If you're considering a global fund, you may be missing the boat. International funds hold only foreign securities, while global funds invest in companies in the United States and overseas. So if you want to diversify into foreign markets alone, invest in an international fund.
You should also know foreign investing is subject to certain risks, such as currency fluctuations and social, economic and political changes, which may result in greater share price volatility.
6. I want my CNBC. What's the first thing you do in the morning? If you switch on CNBC, get your fix of The Wall Street Journal or check your stocks on the Internet before you pour your coffee, you might be obsessing over the stock market. It's true such diligence could lead to profits, but it could also lead to needless worry, panic and way too much trading. It's important to pay attention, but it's bad to be too anxious.
7. Where do you want to go today . . . and tomorrow? If Bill Gates hadn't known where he wanted to go, he probably would have ended up somewhere else. The same goes for your portfolio. If you're saving for a goal that's five, 10 or 20 years away, your reactions to the market's fluctuations will likely be different from those of someone whose focus is on speculation and short-term gains. If the lofty levels of stocks have you spooked, consider dollar-cost averaging into investments you'd like to own. By making smaller purchases on a consistent schedule, you could be in a better position to take advantage of the market's fluctuations without a lot of headaches.
8. Know thyself. Many people don't know their risk tolerance. Ask yourself how you'd feel if you invested in a stock and two weeks later, only half of your investment was left. If you get sick just thinking about it, then maybe the stock market isn't for you--at least when it comes to investment fads, hot tips and initial public offerings. If you can't afford to lose some money, consider other investments.
9. Ain't nothin' like the real thing. Face it: 20 percent average annual returns are not an inalienable right. The past several years have proved to be remarkable, but that doesn't mean the bull will run forever. It also doesn't necessarily mean the market will crash and return to the 6,000 point level. To paraphrase Rudyard Kipling, "He who keeps his head keeps his sanity (and his wallet)." Babe Ruth had one of the finest batting averages in history, and even he struck out sometimes. So if you expect your portfolio to swing for the fences every year, you'll probably end up disappointed.
10. Know where your advice is coming from. What kind of license does your financial advisor hold? Has your registered representative received a bevy of customer complaints? If possible, speak with him or her in person or over the phone and get a feel for his or her style. Make sure your advisor understands your objectives, and be honest about your goals and expectations. To verify a potential advisor's experience, call the National Association of Securities Dealers Inc. at (800) 289-9999. If you're considering a certified financial planner, call the CFP Board of Standards Inc. at (888) CFP-MARK.
Lorayne Fiorillo is a financial advisor and first vice president of investments at Prudential Securities Inc. Past performance is no guarantee of future returns. For more information, write to Lorayne in care of Entrepreneur, 2392 Morse Ave., Irvine, CA 92614.