Common Stock Investing Mistakes
As we go into 2008, let’s recap some of the common mistakes we all make and strive to avoid making them in 2008.
1. Trading too often. This largely depends on the size of your asset base. If you only have $10,000 to invest, making about 50 trades a year at $10 a trade is $500, or 5% of your asset base! That’s just about one trade a week, but it takes up 5% of your money. So even if you make 12% returns (beating the historical returns of the market), you’ll only make 7%, well below the historical returns of the market. If you have a large asset base, you can afford to trade more often. But for most people, try to keep commissions low.
2. Selling scared.Sometimes, it’s time to face the music and sell a stock that’s been a loser. However, you shouldn’t sell just because you’re scared. You should sell if you think it makes rational, logical sense to close a position. Many times, people sell stocks because the market had a bad day and they’re afraid it will go lower or the stock itself had a bad day. This later turns out to be a bad decision when the stock shoots back up.
3. Not keeping any cash on the side.I have to credit Jim Cramer with this tip. This was one of the biggest newbie mistakes he talked about on his Mad Money show. When you are fully invested and have no cash, you can’t take advantage of the market when it has a bad day. You are also more prone to panic selling and making other fear-related decisions. He recommends keeping at least 10% of your portfolio in cash, which I think is a pretty good tip.
4. Buying fad stocks. Sometimes, popular “cool” stocks do well. Examples from 2007 would be Chipotle and Apple, both of which more than doubled (in full disclosure, I own shares of Chipotle). These companies are solid companies with excellent growth, so the gains are justified. Often times though, people buy shares in a stock just because other people are buying shares. The obvious example is the tech bubble, when people were paying exorbitant prices for companies that weren’t even close to turning a profit. The psychology behind people’s willingness to buy these stocks was largely because other people were buying them, so they figured people would continue to buy them. That’s not a good reason to invest in a company (in fact, it’s a horrible one for long-term investing). When investing for the long-term, always make sure the fundamentals are good.
5. Investing in too many stocks. This is another tip I’m borrowing from Jim Cramer. Too many of us buy too many stocks and can’t follow-up with the companies. We often barely know what we’re investing in and have no gameplan in regards to the stock. I know I make this mistake often. If we want to diversify, it’s easy enough to just buy an index fund or ETF. If we end up investing in 50-100 individual stocks, we effectively become our own mutual fund, but without the resources to adequately monitor the companies we are invested in.
