The following is a guest post from Stock Investing 101.
The eight biggest mistakes investors make:
1. Investing in style instead of substance. Too many times investors look for the next Microsoft, Apple, or Google. While it is important to devote a significant portion of your portfolio to more speculative growth oriented companies the bulk of your portfolio should be in stable, profitable, dividend paying companies. Over the last 50-100 years most of the gains investors have seen from the stock market have come from dividends and not the price of a stock actually appreciating. Value companies have noticeably outperformed growth companies over every time frame you could think of. A portfolio featuring Johnson & Johnson, General Electric, and Exxon Mobil might not be as “sexy” as one featuring Baidu and Apple but you will likely get better returns in the long run with the former.
2. Trading too regularly. Investing is not easy, making a profit by trading is almost impossible. The pro’s of Wall Street have trouble with trading and being profitable over time, what makes you think you will make a fortune doing it? Even if you think that you have a proven day trading “strategy” your plan will likely be foiled. Humans are driven by emotions. Losing money is actually one of the strongest emotions that can be evoked. You will be struck with the urge to sell the second that your “trade” turns south which will ruin your chances of succeeding.
3. Not diversifying. The average investor makes two different mistakes when it comes to diversification. The first is holding way to much of their companies stock. No single stock should ever make up more than 10% of your portfolio, no matter what. You are already counting on your company for your paycheck and livelihood, it is definitely not a good idea to rely on your company for any more than you need to financially. The second mistake is having too much of your portfolio in one sector. If your portfolio was full of tech stocks in the early 2000’s or financial stocks a few years ago you would be wiped out in an instant. Do not let one sector make up more than 20% of your portfolio.
4. Investing in mutual funds instead of index funds. Mutual funds lose to indexes 80% of the time once you factor in all of the fees that they can and do charge. Why would you ever make a decision where there is an 80% chance that you would be wrong? The 2% fee that mutual funds normally charge a year may not seem like much but it is huge over time. Once you factor in the fact that many funds charge front or back end loads, the choice is clear. Index funds charge .1-.2% in fees and do not have any loads. You will be getting the same return the market gets which is all you should need to succeed over time.
5. Ignoring the rest of the world. It is not wise these days to devote 100% of your portfolio to American companies. China and other countries are growing very quickly. China is expected to grow its GDP at 8% a year when America is growing at between 0-3%. American companies should still make up the bulk of your portfolio but save 15-30% for companies in China and elsewhere.
6. Chasing a stock. You do not have to buy shares of a company that have been up 10% in a month or 40% in a year. The company is likely due for a pullback in price. If the price of the stock does not pullback then move on. You should never have any emotional attachment towards any investment. There are over 10,000 stocks in America alone that you can invest in, there really are more fish in the sea.
7. Selling low and buying high. Individual investors actually get much lower returns over time than the market does because of their tendency to sell low and buy high. Many of my friends and family members dumped the majority of their stock market investments in the beginning of 2009 when things where looking pretty rough in the stock market. This was the best opportunity to buy into the stock market in years or even decades. If you must, set up your portfolio to where you automatically buy shares of various companies at the same time each week or month.
8. Not investing early enough. When you start investing is more important than how much you invest believe it or not. If you invest at least 15-20% of what you earn from the time you start working you will be very well off and retirement will come much sooner than you think. The difference between beginning to invest at 22 and starting investing when your 35 is huge. Getting a 8-10% return on your money, what you will get over time in the stock market, will not do amazing things to your investment in 1, 3, or 5 years. However because of the power of compound interest your portfolio should skyrocket after 20+ years.
Great list. Personally I'm following 7 of the 8 suggestions. The one I missed was the 8th. I'm making up for that now by living frugally and saving around 60% of my gross earnings while I play catch up.
Posted by: RetirementInvestingToday | February 02, 2010 at 06:23 PM
Good solid advice.
I tend to use a core and tactical approach of investing, where 90% of my portfolio is balanced between mutual funds, (I'm thinking of moving some to ETFs though), bond and cash... then 10% tactical, where these are stocks and speculative stocks (I'm not brave enough to try calls and puts yet).
Posted by: Mone | February 02, 2010 at 07:06 PM
I have a difference of opinion on item 4).
There are two types of mutual funds - Actively managed funds & Passively managed funds.
Index funds are passively managed. It doesn't take much experience at all to learn how to construct a portfolio that matches a market index closely. It doesn't require that every stock in the index be purchased in the same ratio as it exists in the index. There are other techniques available that enable a person with little experience to construct an index fund that can match the market index, the inverse of the market index, or even a positive or negative multiple of the movement of the market index. This has led to the formation of companies such as Rydex and ProFunds that specialize in this area. If you buy an Index fund all you are guaranteed is that its performance will closely match that of a particular market index.
Actively managed funds are a whole different Ball Game.
They require the skills of a very experienced fund manager and a team of professionals that carry out research on selected companies, and continue to stay in close contact with the management of the companies whose stock they own. This obviously costs a lot more, hence the higher fund expenses.
Passively managed funds are fine for investors that do not want to actively manage their own portfolio.
On the other hand, if you subscribe to a proprietary database of mutual funds and market indexes that is updated daily with data also adjusted for all distributions, and you also purchase some very good software that allows you to chart, analyze and rank various families of mutual funds categorized by sectors, countries, types etc. then you can pick out those funds that are currently the top performers. At any given time some sectors are Hot, some are Cold, and many are Mediocre.
With these capabilities you have what it takes to invest in the very best performing funds and make intelligent decisions about when to Buy, Sell, or Hold particular funds.
I have never bought a passively managed fund because I have the time, data, software, and skills necessary to work with actively managed funds. This way for the 11 year period starting in 1993 when I retired I was able to average 26.3%/year which was two to three times greater than any of the major market indexes. I still subscribe to the database but as I became older and wealthier I reached the point where I wanted to severely limit risk and thus I now only own CDs and Bonds and it doesn't bother me at all when the market has a very volatile day..
I never chased stocks because I learned early on in life that owning individual stocks can be deadly - mutual funds provide the diversification that is an absolute necessity for small investors.
Posted by: Old Limey | February 02, 2010 at 08:47 PM
I struggle with the "Too much money in company stock" part. It is so easy to buy at a discount that I feel the need to. I guess I just need to sell it more frequently and move the money elsewhere. PAY OFF THAT DEBT NOW!
Posted by: Dollars Not Debt | February 02, 2010 at 10:11 PM
MasterPo disagrees with #6 & #7.
While it's true if you buy in after a run up you're buying at a high, when else are you going to buy in? When the stock is languishing at some low for months or years at a time *hoping* for a turn around?
The ideal is to catch the stock when it starts it's rise. But that's more market timing than investing.
It is sometimes said people waste money chasing last years winners for there's no guarantee they will be this year's darlings too. Probably not.
But if you don't chase the winners what do you chase - the loosers?? ;-)
Posted by: MasterPo | February 03, 2010 at 12:44 AM
@Old Limey - as someone who is not in your position but looking to get there, can you provide more specifics on how to actively manage mutual funds? For example, specifically what propriety software and techniques do you use?
Thanks!
Posted by: texashaze | February 03, 2010 at 05:43 AM
thx for the advise .... lemme follow 4, 6, 7, and 8 I hope it helps me much
Posted by: James | February 03, 2010 at 06:04 AM
@texashaze
I don't want to include a link since I don't want to be considered a spammer.
However just do a google search on 'investors fasttrack' and it will take you to a company in Baton Rouge, LA that provides proprietary stock and/or mutual fund databases that go back to 1988. The database also comes with very good charting and analysis software. The software takes a bit of understanding but they also have two instruction DVDs that would make learning a lot faster and easier. It takes about a minute to update the database every market day about 3 1/2 hours after the market closes.
I have no financial interest in the company whatsoever but have been a subscriber since 1993 when I answered an advertisment in Investor's Business Daily.
As for techniques, there's a lot too learn but if you work your way through the instruction DVDs you will be off to a good start.
Posted by: Old Limey | February 03, 2010 at 11:19 AM
Re Item 7)
I have always been a Momentum Investor.
In a nutshell, the concept is: BUY HIGH - SELL HIGHER
You detect breakouts in a fund - you then buy it - you hold it until it declines by a certain amount and then you sell it. You have to have charting and analysis software on your computer in order to use this technique. The methods of determining Buy and Sell points are subjective and vary from user to user.
One indicator that is very popular is the 'Relative Strength Index" or RSI, a method developed by a man called Welles Wilder in 1978.
Posted by: Old Limey | February 03, 2010 at 11:34 AM
Thanks Old Limey! I'm about to change jobs and companies which means a substantial 401k will be freed up to all stocks and funds rather than the select few offered by the company sposored 401k. Fidelity appears to be the best service house in terms of cost, offerings and quality of services. Anyway, what to do with the money has been an area of concern. We tried a full service broker and were greatly disappointed - they don't do much for you and cost a heck of a lot.
If anyone has other advice please share.
Posted by: texashaze | February 03, 2010 at 01:50 PM
I suppose I can nit-pick on the details, but overall, I think the spirit of this entry should resonate as loud as possible to as many people as possible.
And yes, I say this even though I do trade stocks.
But the reason why isn't so much because I think I am smarter than the rest of the market or that I can make money. I do it because, well, everybody has a hobby eh? And so, this is mine. There's no better way to learn about the stock market and the forces of economy than to participate in it yourself.
Fortunately, this isn't like jumping out of an airplane with no parachute or swimming with sharks with a T-bone steak tied to your head. No, it's just a portion of my portfolio; money I can afford to lose if something goes terribly wrong.
But going through the trials of stock trading myself-- and seriously considering leaving to go completely passive-- I can tell you that you can't beat the market consistently.
Posted by: Eugene Krabs | February 03, 2010 at 02:09 PM
@texashaze
I am not a lover of stocks but the one that I remember well was Chrysler, back in the 60's my broker recommended it and it tripled but many others were big losers. Chrysler provided the downpayment for our first home.
Fidelity is where I keep everything. You will love their Active Trader Pro software for keeping track of everthing and for placing orders. They have another package that I know nothing about other than that it seems geared to day traders. Their customer service is great but they don't give advice on what to buy or sell. Fidelity also has a large selection of CDs, and Corporate & Muni Bonds.
My son's 401K is at Fidelity and it also only offers 24 very ordinary funds. I manage it for him and it has been in Pimco's Total Return fund for the last few months.
Posted by: Old Limey | February 03, 2010 at 08:13 PM
Today was a good example why keeping up-to-date on what's happening in the world's economies as well as watching indicators that show the current health of the US market can really pay off by keeping you out of issues that are declining and in issues that are advancing.
It's not only about not using a Buy & Hold strategy, it's more about using fund selection and sector rotation. There are times when you just have to move out one fund and into another if you want to succeed.
However to do sector and fund rotation you have to have a comprehensive database of funds and market indexes, you need to have the funds all grouped intp various families, and you need some good charting and ranking software. It's all available from several sources but isn't free.
It takes work and time and I am the first to admit that when I was devoting all of my energies to advancing my career and doing the best I could for my employer I could have never kept up with what's happening in the financial markets the way I have done since I retired in 1992. Many people just aren't interested, and if you don't have the interest and the time you just as well stay with Buy & Hold in a fund that tracks a broad market index. The problem is that you may have a great year like 1999 and then give it all back in 2000 and continue on to be one of the many investors that are always bemoaning how poorly they do.
By way of example, Vanguard's VFINX fund tracks the S&P 500 incl. dividends, it's return over the last 10 years ending today has been -1.19%. It's hard to build a retirement nest egg with that kind of performance.
Posted by: Old Limey | February 04, 2010 at 08:52 PM
No. 4 It doesn't matter, if the market's going down, you're going down. No. 7 - Duh.
Posted by: livetozero | January 12, 2011 at 12:14 PM