10 Mistakes Every Investor Makes & How To Avoid Them Part 2
Yesterday I gave you 5 of the 10 mistakes that every investor makes. This includes everyone from stock brokers to day traders to real estate investors, we all fail at one of these every once in a while. But it is better to be forewarned than to be left holding the bag after making a simple mistake.
When people think of investing they do not necessarily think in terms of all of there appreciable assets. That would be a mistake. You should be trying to increase your net worth on all of your investments throughout your lifetime. You will probably need it by the time you reach retirement so keep your eye on the prize. Optimize each asset and investment and you will do well.
Mistakes 6 through 10 are as follows:
Mistake #6 – Failing to Readjust Portfolio
There is a good reason why financial advisers stress having abalanced, diversified portfolio – because you will always have losers. By being adequately diversified in the proper asset classes, you
balance your risk and reward by distributing your funds in a way that are in line with your financial goals. Depending on your age, risk tolerance and investment horizon, there are recommendations on how you should divvy up your capital. Here is a chart that I found at Bankrate.com, a very good site.
Asset Allocation Table
As some asset classes will earn more than others, over time your portfolio will become unbalanced and require you to make adjustments to get back on track. Likewise, if your investing rules are to have $1,000 in shares spread across 5 stocks, your portfolio will also require some maintenance. As a result of some stocks increasing in value and others decreasing, you may need to sell where you experience gains in order to buy more shares that are experiencing loses and are still great stocks to own.
Mistake #7 – Denying Defeat
When an investment doesn’t go the way it was intended to, investors often make a big mistake of holding on to their losers in hopes that they will rebound. This should not be the case, as the investor’s rules should have a clear exit strategy for both winning and losing positions.
Nobody wins all of the time, and admitting that you were wrong can be a tough thing to do. If an investment goes south, it’s important to ask why and re-evaluate the position by asking:
- Was something overlooked and you inaccurately valued the stock?
- Did something change fundamentally, such as a change in management, decrease in sales because of a new competitor, or a change in laws?
- Is this just a short-term reaction that provides an even greater opportunity?
How you decide when enough is enough is up to you. There is no perfect answer as to when to sell a losing stock. Some financial planners recommend a loss of 10% in value, others use a dollar amount or a percentage of total capital.
Mistake #8 – Improperly Valuing Investments
Just because a market takes a sudden dip doesn’t mean the investment is all of a sudden a bargain buy. This goes for both real estate and equities markets. Stocks, for example, have been on a bull run since 2002, but at the end of 2007 and the start of 2008 a great deal of volatility occurred. Technology stocks, among others, took a beating. While technology stocks have significantly decreased at the time this article is being published, they are cheap relative to where they were a year ago.
This does not necessarily make them a no-risk investment. Cheap stocks can always get cheaper. There is still plenty of room for these stocks to fall in order to be rationally valued. Just remember that because there is some instability in the market, that doesn’t mean it serves as an immediate buying opportunity for cheap stocks.
It would, however, be worth determining a suitable entry point and keeping a close eye on, but don’t jump in just because prices are down from yesterday’s highs. Secondly, past performance should not be an indicator of future performance when picking stocks or mutual funds. While a history of providing shareholders with great returns is an important factor when selecting equities, it by no means guarantees future results.
Mistake #9 – Acting on Stock Tips
Think about this: A friend has a tip from another friend who works for a company that is about to report a very strong earnings report. He urges you to jump on the stock in order to make a pile of money on a “sure thing.” The recommendation sounds tempting. You toss and turn all night as you think about how much money you can make if your friend is right. In the morning you decide instead of just buying the stock, you’ll buy 100 call options and make 10 times the amount of money you would with a stock.
Obviously this decision has a few problems. For one, it constitutes insider trading, which is illegal. Secondly, it violates any rules of protecting your downside by not doing your own research first and determining if this is a company worth owning. Maybe most importantly, what does your friend know about investing? Is he qualified to be giving you expert financial investing advice? Why are you trusting your money on a tip?
Avoid listening to the wrong people who are not qualified to be giving you advice, do your own due diligence, and stick to your rules. If professional investors cannot accurately predict the direction of the market, chances are your friend is not capable of giving you advice. Similarly, just because an analyst suggests that a stock is overvalued during a television interview, this is not a good enough reason to run out and sell the stock.
Mistake #10 – Timing the Market
Because the stock market is a result of company earnings and forecasts, investor psychology, and the institutional house’s ability to move markets in a particular direction with enormous positions, the stock market cannot be predicted accurately. You may be lucky and make an accurate prediction once in a while, but you can also hit black jack at any table in Las Vegas. Trying to time the market is a loser’s game, and for the long term investor it should be an irrelevant concept.
As an investor your focus should be to regularly invest in a well diversified portfolio. By regularly investing you take advantage of the market fluctuations by buying more shares when the market goes down, and being a part of the winning crowd when it reverses. This is known as, “dollar cost averaging.” Market timing does not have a place in the wealth equation. The only thing worth timing is to be in the stock market, because over time history proves that it will only go up. That’s the only way to outsmart the market.
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