Four Investing Mistakes to
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
Investing Mistake 2: Not accounting for time
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).