Follow The Rules
"Bulls and bears aren't responsible for as many stock losses as bum steers." --Olin Miller
Recently, a new client came in to meet with 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've 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 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 similar investments. Our investor didn't realize his money-market fund was neither insured nor guaranteed by the U.S. government. And there's no assurance such a fund will maintain a stable net asset value of one dollar.
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.
Wouldn't it be nice to learn from someone else's mistakes for a change, or at least to avoid making the same mistakes twice? With that in mind, here are eight of the most common errors made by astute (and some not-so-astute) investors. Tally up how many of them you've made, and review the sections you're weak in. If you tick off fewer than two, consider yourself an expert; three to five, you need some help; six to eight, it's time to brush up on the basics of personal finance! Read on to see how you fare.
Lorayne Fiorillo was an Entrepreneur columnist for five years. A senior vice president at a major brokerage firm and a financial advisor since 1986, she currently manages over $120 million in assets for more than 600 clients.
1. One-Stock Investing
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, if this is the dominant position in your portfolio, consider selling a few of those shares and diversifying. (Before you do, however, be sure to check with your tax advisor.)
It's a strange but common phenomenon that the person doing the selling usually values an item at a higher price than the one doing the buying. If you're holding shares of a stock because you can't bear to part with them, consider what might happen if their value were cut in half. If such a situation wouldn't be devastating to your finances, hold on, but if just the idea of it is making you sick, lighten up your position.
2. Sticking To Hot Funds
If you're seeking a few good mutual funds and have set your sights on a few of last year's hottest properties, 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 not an indication of future returns," is especially meaningful here, as the performance of investments over time shows a regression toward the mean. In other words, investments that show far superior performance will tend to cool off while less-than-stellar funds may pick up the pace over time. Worse yet, a hot fund could cool off just as you're getting into it.
Consider looking for fund managers with good long-term track records whose funds are out of favor (and therefore 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.
3. Failing To Sell High
How difficult can it be to buy low and sell high? For many of us, it's next to impossible. It seems that lots of folks (your brother-in-law, your golf buddy, even your broker) can tell you when to buy a stock, 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 stay or do you go? Unfortunately, no one has a crystal ball. You may have a pharmaceutical company with the cure for cancer on your hands--or maybe it's just a rash. 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, re-evaluate your decision. If you'd buy the stock anew at the higher price, there may still be some room left for more appreciation. Consider buying puts (options to sell) or entering a stop-loss order (an order to close at a set price) to protect your profit. If you sell, don't look back unless the price falls to a point where you want to pick it up again.
4. Relying On P/E Ratios Alone
If you lean toward value investing, one of the things you look for is a low price-to-earnings, or P/E, ratio--but it may not make sense to find those stocks whose P/Es are at their lowest historical level. Such stocks may have sunk for a reason, and they may be slow in returning to health. Instead, consider stocks with P/Es that are low relative to companies in the same industry but have had positive earnings in recent quarters. These stocks are more likely to rebound and make money than those that are really in the bargain basement.
The same goes for evaluating a mutual fund. While the names of some funds suggest they are value types, they may be investing in many momentum stocks (any fund that performed well in 1998, for example, had a large dose of technology stocks in it, no matter what the fund was called). Check its annual reports to be sure your fund provides the style you seek.
5. Watching Too Closely
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 pouring your coffee, you might be obsessing over the stock market. Although such diligence could lead to profits, it could also lead to needless worry, panic and way too much trading. Pay attention, but don't be too anxious.
Worse still is letting those talking heads go to your head. By the time you've heard it on national news, you're hardly the first to act. A lot of financial information is just that--information. Interpreting that information is what separates winners from losers. Unless you're a very experienced trader or plan to make trading your full-time occupation, resist the temptation to day trade. This isn't investing; it's gambling. And while it may be an avocation for some, it's a dangerous addiction for others.
6. Not Looking Long-Term
If Bill Gates hadn't known where he wanted to go, he might 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 won't be the same as if you were focused on speculation and short-term gains. If high-priced stocks have you spooked, consider making small 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.
Also avoid the all-too-common mistake of ignoring your IRAs. Many investors pay too little attention to these beautiful accounts. Some people scatter them about, earning a meager interest rate because the bank or brokerage firm had an offer that was too good to pass up at the time. That toaster you got is probably obsolete, but so might be the IRA that came with it. Consider consolidating these accounts and making them a vital part of your financial program.
7. Letting Portfolios Fall Stagnant
Despite what the pundits say, average annual returns of 20 percent are not an inalienable right. The past several years have proved to be remarkable, but that doesn't mean the bull will run forever. But it doesn't necessarily mean the market will crash either. To paraphrase Yogi Berra: Investing is 90 percent mental--the other half is monetary. 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 in the minor leagues. Give your portfolio a break by periodically rebalancing your assets.
8. Taking Advice From Bad Sources
While a stockbroker may have an insurance license and an insurance agent may be fluent in mutual fund lingo, these areas are too complicated and change too quickly for anyone to be an expert in both. Think of it this way: If you broke your arm, would you call a veterinarian? While he could probably set your limb, your fur may never grow quite the same way. By acting as a consultant, your financial advisor can help you reach your goals more efficiently and with a lot fewer mistakes than a specialist.
You should be equally careful about what advice you take from investment newsletters. While some provide substantial expert advice, others are worth less than the paper they're written on. Check a writer's track record before "subscribing" to their ideas.
New Blood
Have too much riding on one stock? Variations on this theme include keeping too much company stock in your 401(k) plan or holding off too long to exercise options. The key to avoiding this mistake is "diversifying to conquer."
Hit The Books
Though you may not agree with all his ideas, check out 25 Myths You've Got to Avoid If You Want to Manage Your Money Right by Jonathan Clements (Simon & Schuster). Clements breaks open many cherished theories on managing personal finances, and his style will make you alternately cringe and laugh.
Look Ma, No Hands
There are several ways to consolidate IRA accounts. Rollovers, allowed once per year, entail taking receipt of the funds and transferring them to another institution within 60 days. This method of consolidation generates a notice to the IRS, so be sure you keep your paperwork in order; you'll need it if questioned.
With a direct transfer from one custodian to another, assets never touch human hands (at least not yours), and the IRS doesn't usually receive a notice. Make your life easier, and let your new custodian's fingers do the walking.
You Talking To Me?
Got a hot tip from a voice on the radio? A talking head on TV? A nom de plume on the Internet? Be wary of "expert advice" and "inside tips" from these sources. Just because it's financial advice doesn't mean it's appropriate for everyone.