5 Investing Mistakes Rookies Make
Everyone makes mistakes. No one is immune. Mistakes with money, particularly money invested for retirement or a child’s education can be horrible. However, many investing mistakes can be avoided, and that’s what this piece is all about.
Living in a Vacuum
This is the first and most common mistake market investors make. Markets are volatile! If you are invested, you must be aware of what is happening around the globe. Almost everything affects the stock market. A recent example is the fraudulent Associated Press tweet regarding a bombing at the White House that injured President Obama. Even though it wasn’t true, the market dropped 125 points! If you are going to invest in the stock market, you need to keep an eye and an ear on current events and develop an understanding of how those events may affect your investments. In short, you must devote some part of each day to the financial, political and global news. Not only is this necessary to making sound decisions with regard to your current portfolio, it is a must to help you decide what investments you will make in the future. Buying a stock and forgetting it is not an option.
Looking at the Tree and Ignoring the Forest
Too many investors select a stock based upon one or two metrics—the most common ones being the Price to Earnings ratio or P/E ratio and the price to earnings growth ratio or PEG. Now both of these metrics are important and can be helpful in selecting a stock, but don’t make the mistake of relying on just one or two metrics. Why? They do not tell the whole story. Let me give you an example. Amazon has a terrible P/E! The forward P/E is over 70 and the PEG is equally dismal at over 5! Yet, this stock which sold for around $80 in May of 2008, now sells for more three times that amount. If you had based your investment decision on P/E and PEG, you would have never bought this stock! The second biggest investment mistake you can make is to allow your decisions to be guided by one or two metrics, ignoring other important metrics in the process. Look at the forest, not just a couple of trees.
Failure to Understand the Investment
Warren Buffett, the “Sage of Omaha,” is one of the most respected investors on the planet. His maxim: “Don’t invest in something you don’t understand.” I couldn’t agree more. The most successful investor, understands what he is buying, understands the risks and, most importantly, has done his homework! Before you buy a stock, you must read the company’s prospectus. This will tell you where the company has been and where it is going, or at least where it hopes to go. It is important for you to understand the company’s business, what need it answers, what future it has based upon your knowledge of the marketplace. If an investment doesn’t make good sense to you, then take a pass. It’s that simple.
Follow the Fads or the “Gurus”
If you follow current investing fads or try to duplicate the trades of so-called gurus, you are abandoning the first three pieces of advice I have given you. It’s bad enough to make mistakes, worse yet to make the same mistakes others are making. I would argue that you are always better off trusting your own judgment, provided, of course, you avoid the mistakes outlined here. Fads come and go and the gurus you choose to follow may have a hidden agenda in their investment choices that will not necessarily benefit you. Most gurus are hedge fund managers. Isn’t that all you need to know?
Make Frequent Trades
Time heals all wounds—well, maybe not all wounds, but it is difficult to argue with the fact that a good company, prudently vetted and appropriately analyzed, will, over time, grow in value. Yes, there may be ups and downs, but history shows that the stock of good companies will grow in value. Perhaps no better evidence for this exists than our recent financial crisis in which the market, as a whole, lost more than one-half its value but has, over the past four years, recovered its value and then some. The final lesson then is to stand by your stock investment, assuming, of course, your selection process follows the guidelines listed here.