7 Investment Mistakes to Avoid
"Mistakes are part of the dues one pays for a full life."
-- Sophia Loren
Just like you, I want the best stocks at the best prices. But like most worthwhile pursuits, the road to profits is often laden with potholes. Even the most successful buy-and-hold investors, such as Warren Buffet and Peter Lynch, have made their fair share of mistakes. By seeing potential potholes, you can easily maneuver around them to keep your investments providing stable, long-term returns.
Waiting it out
Myth: You need to be old and rich to invest. Fact: Investment strategies exist for all ages and income levels. In fact, the sooner you start investing, the better -- compound interest can juice your returns over time. I'm proud to say that this powerful factor worked in my favor in October 2003 when I purchased Apple for $23 a share. I wasn't rich, but I believed in the company enough to invest a modest amount in shares that I still own today.
Following the crowd
Investors who follow the herd by pulling money out of stocks during a sell-off, and pouring money in during the height of the market, do so to their detriment. It's quite likely you won't make any money with this type of emotional investing.
It's easy to panic when pitted against the mood swings of Mr. Market. Stock prices fluctuate on a regular basis, forcing investors to manage some degree of risk. The Dow Jones Industrial Average (Index: ^DJI) has suffered from market volatility since early August, with triple-digit swings becoming the norm. Investors who sell out when the market heads south only add to the market's volatility. Instead, stand by your stocks as long as the fundamental thesis of the company hasn't changed.
Investors who track down stocks that have recently peaked in performance are setting themselves up for a loss -- a mistake I'm guilty of. Intoxicated by the hype surrounding salesforce.com (NYS: CRM) , I purchased shares on the sole basis that its price was rising. At the time, I had little understanding of how cloud computing worked, which is an integral part of the company's customer relationship management services.
Since buying shares in March, I've lost 10% of my initial investment. Had I done the proper research instead of chasing performance, I would have seen the risk involved with CRM's wide price swings. I still own shares of CRM, and at a shocking trailing price-to-earnings multiple of 572, it is my riskiest play to date.
Lacking a plan of attack
As Laurence Peter says, "If you don't know where you're going, you will probably end up somewhere else." For investors, knowing which road to travel can make all the difference. Understanding your risk temperament is a critical aspect of knowing what type of investing strategy is right for you. How much can you tolerate to lose? Putting together an investment plan with money you're comfortable parting with for at least five years (preferably 10) can help minimize risk and maximize your investment returns.
Overconfidence in "experts"
No matter how wonderful a money manager's past performance may be, investment institutions ultimately make money on the exorbitant fees they charge. Truth is, most managers underperform their benchmarks and lag their peers. Past performance is not a guarantee of future results, particularly over time periods of three years or less.
Baird conducted a study of the top-performing money managers over a 10-year period. The results revealed that 81% of managers fell below the average of their peers on an annualized basis in at least one three-year period -- further evidence that short-term investing may carry more risk. Investing with a money manager is OK, but don't rely on past performance alone.
Paying too much in fees
The higher the fees you pay for investing advice, the lower your overall return. Investment guru John C. Bogle has said, "In investing, you get what you don't pay for." As an investor, you assume 100% of the risk because you've put up 100% of the capital, but collect only a portion of the profit. The missing profits go to the fund manager who put up 0% of the capital, and risked nothing on the deal.
Investing in what you don't know
Buying stock in a business that you don't understand can lead you to the doorstep of a company like Bank of America (NYS: BAC) , whose shares have lost a quarter of their value in the past month due to concerns about potential capital shortages and mortgage lawsuit payouts. Before investing in a company like Bank of America, it helps to have a broad understanding of the financial services industry.
Berkshire Hathaway's (NYS: BRK.A) (NYS: BRK.B) Warren Buffett has that understanding of financial stocks. He advises investing within your "circle of competence," a strategy that helped his company avoid making investments in the dot-com bubble of the late 1990s. Investing in what you know requires an understanding of how a company makes money. Berkshire's recent $5 billion investment in B of A is similar to past investments the company has made, including American Express (NYS: AXP) and later GEICO. Because Buffett understands the business, he knew how to avoid the worst of the losses and get in at the right time. Avoid unnecessary risk by investing in what you know, and always research a company before buying its stock.
Your financial success
Making mistakes is a reality of investing, but the Motley Fool's CAPS community offers a great platform to learn from each other's mistakes. By avoiding these common investing mistakes you'll be on the road to profitable investing in no time. Take responsibility for your investments by accepting the uncertainties and learning from the setbacks. Share your mistakes in the comments below.
- Add Apple to My Watchlist.
- Add Bank of America to My Watchlist.
- Add Berkshire Hathaway to My Watchlist.
- Add Salesforce.com to My Watchlist.
- Add American Express to My Watchlist.
At the time this article was published Fool contributor Tamara Rutter owns shares of Apple and Berkshire Hathaway. Follow her on Twitter @TamaraRutter. The Motley Fool owns shares of Bank of America, Berkshire Hathaway, and Apple. Motley Fool newsletter services have recommended buying shares of Apple, Berkshire Hathaway, and Salesforce.com, as well as creating a bull call spread position in Apple. A separate service has recommended shorting Salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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