December 2008

Six Common Investor Mistakes

When it comes to investing, consumers often make the same mistakes time and time again, according to a recent survey by the Chartered Financial Analysts Institute (CFA). Below are six of the most common investor mistakes and some tips for how to avoid repeating these blunders.

False Sense of Diversification - Many investors often believe they are fully diversified, when in fact they are not. Many investors frequently confuse mutual fund diversity with investment portfolio diversity. They believe that if they are invested in many different mutual funds, they must be well diversified. However, in many cases, numerous investments may share the same assets, which means your portfolio can be over-weighted with overlapping shares.

Tip: A truly diversified portfolio will have investments in many different asset classes, including bonds, bond funds, stocks, cash and or cash equivalents as well as in holdings that encompass different types of risk.

In other words, diversification, works hand in hand with asset allocation by increasing the chance that, if and when the return of one investment is falling, the return of another in your portfolio may be rising. Warning: If you participate in your company’s stock option program, it is important to make sure that your portfolio is not overly invested in these shares. If the company should see a downturn or go into bankruptcy, you could find yourself out of a job with a demolished portfolio.
Buying High/Selling Low - Investors know this time-honored advice, but consistently make this error over and over again. It is easy to get excited about a sector of the market or stock that is hot. The tendency is to go in like gangbusters, but you may be too late and this hot investment may have already reached its peak. Likewise, it is easy to get discouraged when your investments are sinking, but this might just be a temporary downturn.

Tip: Take the emotion out of your investing. One way to do this is by practicing dollar-cost-averaging, which is the practice of investing a set amount of money on a set timeline, say every month or quarter. This strategy will help ensure that your money is purchasing more shares when prices are low and fewer when prices are high. It will also help you view your investments in the long-term and take advantage of compounding. (Dollar Cost averaging does not assure a profit or protect against loss in declining markets).
Market Timing - Many investors take the strategy of buying high and selling low to an extreme by deciding which stocks to buy on a day-by-day, sometimes minute-by-minute basis. This strategy is called Day Trading.
Other investors try to predict the ups and downs of the market based on past stock market patterns such as the “Santa Clause Rally or January Effect” - a common seasonal spike in the market after Christmas and through January.
The biggest risk associated with marketing timing is the possibility of missing out on the best performing cycles. Missing just a couple months could substantially affect your portfolio.

Tip: Day trading and guessing which way the market will go based on the month is usually a losing battle. Your best bet is to think long-term. A better alternative over the long run may be a buy and hold strategy while considering both your time horizon and your goals.
Buying and holding - but not forgetting - While “buy and hold” is generally a common and sound strategy, it shouldn’t mean you should forget about your investments. If you are not paying attention, your portfolio may diverge from your set asset allocation leading to more risk then you may be willing to take.

Tip: A buy and hold strategy should include regular portfolio checkups and rebalancing at least once a year. Rebalancing is the act of selling some of your well performing investments to purchase under-performing investments.
Doing regular check-ups and taking appropriate action will keep your portfolio in-check and help prevent incurring more risk.
Investing in Stock, Not in Companies - Some investors get caught up in the rationale that if they love a company’s product or service, the company would therefore make a great investment. Many other investors ignore the company altogether and focus only on financial charts. However, focusing solely on the charts does not allow for in-depth, critical analysis.

Tip: Before you invest ask yourself some key questions focused on the company not the stock. For example, is the company becoming more profitable each year? Are the companyπs products in demand? Who are their major competitors? Is the company keeping up with industry changes? Instead of individual stocks, many investors prefer to buy stock mutual funds, which provide instant diversification and spread risk among many different securities.

No Investment Plan - According to Personal Economy Index, survey conducted by American Express Financial Advisers in November 2004, just one in ten Americans have a formal, written financial plan. Most experts agree that both small and large investors should have a financial plan which includes an in-depth view of your financial goals. Your plan should also take into consideration your time horizon for these goals, how much you are realistically able to invest, and how much risk you are willing to take.

Tip: Seek some professional help. A qualified financial advisor can help you develop a comprehensive plan that includes a detailed investment strategy.