Four Investing Mistakes to Avoid
Don't Become Your Portfolio's Worst Enemy
Investing Mistake 1: Spreading your investments too thin
Over the past several decades, Wall Street has preached the virtues of
diversification, drilling it into the minds of every investor within
earshot. Everyone from the CEO to the delivery boy knows that you
shouldn't keep all your eggs in one basket - but there's much more to
it than that. In fact, many people are doing more damage than good in
their effort to diversify. Like everything in life, diversification
can be taken too far. If you split up $100 into one hundred different
companies, each of those companies can, at best, have a tiny impact on
your portfolio. In the end, the brokerage fees and other transaction
costs may even exceed the profit from your investments.Investors that
are prone to this "dig-a-thousand-holes-and-put-a-dollar-in-each"
philosophy would be better served by investing in an index fund which,
by its very nature, is made up of many companies. Additionally, your
returns will mimic those of the overall market in almost perfect
lockstep.
Investing Mistake 2: Not accounting for time horizon
The type of asset in which you invest should be chosen based upon your
time frame. Regardless of your age, if you have capital that you will
need in a short period of time (one or two years, for example), you
should not invest that money in the stock market or equity based
mutual funds. Although these types of investments offer the greatest
chance for long-term wealth building, they frequently experience
short-term gyrations that can wipe out your holdings if you are forced
to liquidate. Likewise, if your horizon is greater than ten years, it
makes no sense for you to invest a majority of your funds in bonds or
fixed income investments unless you believe the stock market is
grossly overvalued.
Investing Mistake 3: Frequent trading
I can name ten investors on the Forbes list, but not one person who
made their fortune from frequent trading. When you invest, your
fortune is tied to the fortune of the company. You are a part-owner of
a business; as the company prospers, so do you. Hence, the investor
who takes the time to select a great company has to do nothing more
than sit back, develop a dollar cost averaging plan, enroll in the
dividend reinvestment program and live his life. Daily quotations are
of no interest to him because he has no desire to sell. Over time, his
intelligent decision will pay off handsomely as the value of his
shares appreciates.
A trader, on the other hand, is one who buys a company because he
expects the stock to jump in price, at which point he will quickly
dump it and move on to his next target. Because it is not tied to the
economics of a company, but rather chance and human emotion, trading
is a form of gambling that has earned its reputation as a money maker
because of the few success stories (they never tell you about the
millionaire who lost it all on his next bet... traders, like gamblers,
have a very poor memory when it comes to how much they have lost).
Rational Thinking is the Key to Profits
Investing Mistake 4: Fear based decisions
The costliest mistakes are usually fear based. Many investors do their
research, select a great company, and when the market hits a bump in
the road - dump their stock for fear of losing money. This behavior is
absolutely foolish. The company is the same company as it was before
the market as a whole fell, only now it is selling for a cheaper
price. Common sense would dictate that you would purchase more at
these lower levels (indeed, companies such as Wal-Mart have become
giants because people like a bargain. It seems this behavior extends
to everything but their portfolio). The key to being a successful
investor is to, as one very wise man said, "...buy when blood is
running in the streets."
The simple formula of "buy low / sell high" has been around forever,
and most people can recite it to you.
In practice, only a handful of investors do it. Most see the crowd
heading for the exit door and fire escapes, and instead of staying
around and buying up a company for ridiculous levels, panic and run
out with them. True money is made when you, as an investor, are
willing to sit down in the empty room that everyone else has left, and
wait until they recognize the value they left behind. When they do run
back in, you will be holding all of the cards. Your patience will be
rewarded with profit and you will be considered "brilliant"
(ironically by the same people that called you an idiot for holding on
to the company's stock in the first place).
