Everyone’s guilty of investment mistakes. Here are seven of the most common blunders to stay away from:
1. Falling in love with the story
If you fall for the story behind a company, or its product, you may not see fundamental flaws, poor market conditions, or overpricing of the stock. Marketing experts agree the best sales job is achieved through telling a story and not by talking numbers and facts. Stories get you emotionally invested, far beyond what plain facts could ever do.
2. Believing things are different this time
Believing you stumbled on something new or different in the investment world can get you in trouble. Simply put, it’s never different. The odds of successful investing never change. No matter the decade, only a certain percentage of investments will outperform the rest. Monumental shifts occur over a lifetime, not overnight.
So stick to the tried and true. Nobody ever went broke by steering clear of new kinds of investments, especially anything that reeks of financial engineering.
3. Confusing good ideas with good investments
Sometimes people will use a product or service — think social media or online gaming — and immediately classify it as a can’t-miss investment. The first mistake is usually the assumption that they are early to the game and have caught something the rest of the investing public has missed. The next mistake is extrapolating personal usage into expectations for more widespread popularity. The third error is expecting wider product adoption to naturally translate into profitability. Lastly, even profitability does not guarantee an attractive investment if the shares have been overpriced.
How many investors held onto BlackBerry for too long because they loved the product, and missed the fact that they were in the shrinking minority? This works in reverse too. Don’t shy away from a stock just because you don’t like the product or company. Hate Wal-Mart? Too bad, because it went up 50% over a three-year period.
4. Reaching for yield
Don’t delve into riskier investments simply to pick up a few extra points of yield. A yield over 7% in this market tends to be a warning sign. A few extra points of yield earned over a year can disappear in minutes when negated by a capital loss.
5. Doubling down
Doubling down is when you’re determined to breakeven on a particular investment. When a stock takes a hit because of bad news, you have with two choices: sell the name because more bad news may be coming, or double up on the number of shares owned so that even a halfway rebound will bring the investment back to par.
This is pure psychology at work. There is almost always a better investment alternative than doubling down.
6. Focusing on the near term
There are plenty of reasons to focus too much on the near term. The vast majority of investment research is based on a 12-month outlook, and portfolio performance is measured on a quarterly, if not monthly, basis. It would be fair to say that because of this, getting the timing right is half the challenge when it comes to investing. Nevertheless, there are times when quality stocks get beaten down by the market for various reasons. All you need is a patient hand.
7. Riding winners too long
Holding winning stocks for too long can be just as costly as sticking with losers. The best way to avoid losing a huge paper gain is to sell gradually on the way up. It’s hard to argue against booking gains, but the psychological hold can be strong. A set approach to selling a proportion of winning holdings at certain levels can help to avoid this investing mistake.
Remember, following rules is investing. Following emotions is gambling.
Dr. Al Rosen, FCA, FCMA, FCPA, CFE, CIP and Mark Rosen, MBA, CFA, CFE run Accountability Research Corp., providing independent equity research to investment advisors across Canada. www.accountabilityresearch.com