Top Money Mistakes, Part II

By Nancy Zambell, Contributing Editor

In last week's issue of Financially Fit, I discussed five major money mistakes that all too often sabotage an entire lifetime of earning, leaving folks facing retirement with inadequate funds to enjoy their golden years. 

If you diligently work to prevent yourself from making those five mistakes (or correct them if you are already practicing them!), you will be, financially speaking, way ahead of the crowd. You will be consistently saving and investing, building a nice cushion for your retirement, as well as for any unexpected expenses that you will undoubtedly face along the way. 

But you're not quite finished, yet. You have learned key principles of expense management and savings, both of which will put much more money into your pockets. But, as your money grows, and you meet your short-term savings needs, you will need to begin investing your extra funds in order to maximize the return on the money you are putting away. 

Unfortunately, the road to successful investing is often filled with traps that will put a serious dent in your nest egg. Consequently, to get the most out of your new financial plan, you will need to studiously avoid some of the most common mistakes made by investors. If you successfully navigate these minefields, you have the opportunity to catapult your funds - and your lifestyle - to unprecedented heights. 

Mistake #1: Market timing is a pipe dream! If you watch the business news shows, you can't help but hear the hype. Interviewers love to chat with market soothsayers who brag about their success in timing the market. And while they may get lucky once in awhile, the truth is no one knows how to truly time the market. 

Advisors and investors have tried to figure it out for decades. It would be a fabulous life if we knew when the market was going down so that we could sell our holdings before the decline. Or, alternatively, think of the riches we could earn if we just knew when to buy before the next bull run. 

But, unfortunately, while some advisors manage to predict a couple of market rises or falls, no one can do it consistently. And even more unfortunate - these market pundits cause unwitting investors to lose a tremendous amount of money by constantly moving in and out of the market. 

University denizens love to perform research on market timing. And in study after study, the results are the same. Frequent buying and selling while attempting to beat the market just leaves you much further behind than those investors who practice long-term investing: buying good quality stocks and holding them until they should be sold. 

If you try to time the market, getting in and out of your stocks, you will undoubtedly miss the very best years and more than likely only be fully invested in the worst years. Why? Because, historically, the markets have had more good years than bad. 

Stocks climbed in more than five out of every seven years between 1926 and 2003. And from 1975 to 2006, there were 23 positive years and 9 negative years for the Dow Jones Industrial Average. 

Since its inception, the stock market has traditionally returned an average 10.8% annually to investors. Profits that were made by sticking with the market through its ups and downs. I recommend that you don't waste your time and money searching for the best  times to be in and out of the market. Just buy the right stocks, set reasonable price targets for them, then hold on until they make money for you, or until you have another reason for selling.  

Mistake #2: Following the crowd will turn you into a loser. Just ask any investor who believed the propaganda of the Internet and technology promoters in the late 90s. In my workshops back then, I displayed the stocks with the highest price-earnings ratios, and then asked the audience if anyone owned them. There were always more than a few hands that rose. If questioned about their purchases, the answers were consistent: "Their prices have been soaring, with no end in sight. They are sure to keep going up."  

Well, we saw how great that theory worked, as thousands of investors were just cleaned out when tech stocks hit the skids in 2000. 

Sure, I understand how tempting it is to buy sexy growth stocks when all the analysts on Wall Street are touting them and when institutions have added hefty chunks of their shares to their coffers.  

And many of these companies will continue to do well for awhile. However, there often comes a time when this "crowd" interest propels their shares to unsustainably high levels, creating tremendous volatility, and risking eventual sharp declines in their prices. 

Why? The answer is simple. Analysts and institutions (pension funds, mutual funds, insurance companies and corporations) follow the herd mentality. When one sells, chances are that the rest are out of the stock hours later. And when that happens, the price of the stock simply crashes and burns. Conversely, when one buys, they all begin sniffing the air, wondering what she knows that they don't, and they jump on the bandwagon. Result: the price of the stock usually goes up. That's when you want to be in the stock - just as the institutions begin climbing on board. Then, when they bid up the shares to an unsustainable level and you are holding a nice profit, you can grab your money and run! 

A good rule of thumb for individual investors: buy shares of companies with fewer than 10 analysts following them and those with less than 40% of their outstanding stock held by institutions. 

By the way, you can find all the information you need on analysts and institutions on any number of websites, but I particularly like http://finance.yahoo.com for this data. 

Mistake #3: Putting all your eggs into one basket. An old, but valid tenet. Diversification is critical to investing success. While it is clearly exciting to see one or two of your stocks climb into the stratosphere, do not be tempted to overweight your portfolio with them, blinded by their heady returns. You will end up with a portfolio entirely dominated and dependent upon a couple of holdings.  

If something triggers a sell-off in these high-flying holdings, your whole portfolio will suffer. Instead, try to diversify among companies, industries, and market capitalization. That way, when one sector or stock isn't performing well, the others might just step in to ensure continued portfolio gains. Sure, you may give up some short-term return, but your overall investment position will be much less risky. 

Mistake #4: Rosy thinking - also known as hanging on to a loser. Here's another rule that will never steer you wrong: It's OK to fall in love with the company, but not the stock. 

A huge part of being a successful investor is discipline. Consequently, you do have to differentiate between loving the company and loving the stock. Fortunately, there are two easy methods for developing such discipline:  

1)      Setting price targets, and

2)      Placing stop-loss orders - either real or mental…

…on your stocks the day that you purchase them. 

And then, when your stock reaches that target, sell it - unless you have a really good reason to hold on to it! The reason should be something stupendous: revenue and earnings growth have rapidly escalated, a reorganization has occurred that will chop expenses by a huge percentage, thereby beefing up earnings, or some other occurrence just as fabulous.  

However, even if those events occur, I generally will err on the side of conservatism. I'll sell one-half my holdings and raise the price target - not as high as circumstances may warrant - but to another reasonable level. 

Then I take my gains and go on to the next profitable investment. 

A second level of protection is the stop-loss order, which is simply an order you issue to your broker (or a mental one to yourself) to sell a stock if its price falls to a level predetermined by you. The reason: to protect you from huge losses if the stock doesn't perform as you expect it to. It prevents paralysis by indecision. 

I realize that not every investor likes to set stop-losses, but even if you don't set a "real" one, you might consider a mental one. At the very least, it will cause you to be on top of the stock's price movement. I advise a range of stop-losses from 20%-30%, depending on the volatility of the stock.  

And one last tip: don't forget to reset those stop losses as your stock price climbs - that's what the pros call "rolling stock losses." 

Mistake #5: Inattention to your portfolio. Many investors make the mistake of diligently doing their research, setting up their ideal portfolio, then promptly forgetting about it! 

Not a good idea. At least once a quarter, I recommend that you review your portfolio to determine if your original investment allocations are still appropriate. If you have a couple of stocks that have gone gangbusters, you may now be too heavily invested in them, and may want to readjust the percentage of your portfolio dedicated to them. 

Perhaps you have entered a different stage of life and want to invest in more conservative equities, or you would like to receive more income. That would also require an adjustment. 

Once you have determined if your portfolio needs realigning, it's time to turn your attention to your individual holdings. 

Equities that have not yet met your target price or dropped below your stop-loss level, should also be reevaluated quarterly, in terms of the fundamental ratios that persuaded you to originally invest in them. I'm not talking about a full-scale analysis (unless there is very good or very bad news, or significant movement in the stock's price), but just a good going-over with a critical eye. 

And then, each and every year, I suggest that you perform a complete reevaluation of each company you are still holding. Ask yourself:  

·        Are all the reasons I originally bought this stock still in place?

·        Is my price target still valid?

·        Can I make more money by substituting an investment with better prospects?

If you are still happy with the company and satisfied with its potential, then keep the stock. If not, sell it and look for greener pastures. 

As you can see, saving and investing don't just happen by accident. It does take a bit of time to create a solid financial plan, discipline to pursue it and a reality check once in awhile to make sure you are avoiding these common pitfalls that can wreak havoc with your plans. 

But establishing a routine habit of socking money away and then paying a little attention to it will set you on the right course to an easier life and a rosier retirement. 

Happy Investing!

This concludes this week's issue of Financially Fit.  We encourage you to visit our website to review past issues of Financially Fit:

http://www.brokeradviser.com/newsletter.cfm


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