Common Investing Mistakes to Avoid
The Key to Being a Successful Investor Lies in What You Don’t Do
Aug 27, 2008
The best way to overcome these pitfalls is simply to be aware of them, so they can be recognized before the mistake is made.
In no particular order, the five frequent investing mistakes best avoided are…
Confusing the Economy with the Market
The media tends to report economic news at face value, assuming the obvious and superficial interpretation is the correct one. Many media sources will go as far as to project the impact economic events may have on stocks. Unfortunately, their assumptions are frequently wrong, or mis-timed.
The reality is, though the economy and the stock market are both cyclical, they are not synchronized. And, there is not always a consistent cause-effect link. Many stocks do well in what’s considered a weak economy, and many stocks do poorly in what’s considered a strong economy.
In short, the media does not validate or check their economic assumptions against the market’s history.
Confusing a Stock with a Company
Good companies should make for good stocks, but they don’t always do. There are plenty of high-performance companies out there with poorly performing stocks. Why? Because company performance doesn’t determine a stock’s price. Other buyers and sellers of that stock determine what that stock is worth, via an auction process on the exchanges. And, their valuation is ultimately a matter of their collective opinion.
An investor only makes money if their stocks go higher, but that’s largely out of the company’s hands. Successful stocks tend to have the favor of the market and its investors as well as strong results from the company.
Unwillingness to Sell
Investors love undervalued stocks, but tend to not to have the same disdain for their overvalued stocks….even if they were originally purchased specifically because they were undervalued. If the strategy was valid at a trade’s onset, by default it should be valid enough for an exit.
The bigger cardinal sin behind an unwillingness to sell a stock is the chance of a small loser turning into a big loser. Psychologically, investors – since they are human – tend to be somewhat stubborn even when it defies logic. That trait may not be healthy for a portfolio if it prevents an investor from making sound, unemotional decisions.
Not Controlling Costs
The era of the cheap online trade has been a blessing for most individual investors, but a few traders have managed their portfolio as if trades are free. They are not.
A $10 trade commission is inexpensive for a $1000 trade – about 1% of the total transaction. A $10 commission on a $100 trade is quite expensive – about 10% of the total transaction.
Considering the stock market’s average return is about 10% per year, a trader incurring relatively high expenses is on track to break even - at best.
Failure to Assess Potential Risk and Reward
Conceptual buying –the practice of buying a stock because the company’s concept or business model is compelling – is quite common. The problem with the practice is that many investors never really crunch the numbers to determine what a stock is actually likely to be worth in the future…or even worth now.
As an example, hypothetically say a newly issued stock is trading at $10 per share, yet the underlying technology is the next big break-through in computers. An exciting concept? Certainly. However, based on independent projections, if the maximum annual revenue-per-share is only going to be $2 per share, then it’s not a wise investment.
In Summary
None of these rules are complicated. In fact, they’re more philosophical than actionable. Yet, incorporating these warnings into an investment approach is not only easy to do, but when applied consistently could successfully preserve the value of an otherwise vulnerable portfolio.
