Even seasoned, smart investors sometimes make mistakes. Here’s a list of six common ones:
Acting on tips. Investors get compelling, authoritative tips from friends. You get “cold calls” from aspiring young brokers pushing companies you’ve never heard of. You get friendly calls from your own broker about stocks you know nothing about. You get urgent messages or “extra-hot” advice from an online news-group discussion. If you act on those suggestions without first investigating, you’re begging for trouble. If your friend or broker knows this hot tip, so do a lot of other people. Assume that this information is already fully reflected in the stock’s price. And if that’s the case, is the stock still worth buying?
Getting sentimental. Falling in love with a stock is a common mistake of retired employees who have accumulated lots of stock in the company they worked for. Children who later inherit those shares have the same strong, sentimental attachment to the firm and tend to hang on. Don’t do it. Weed out the poor performers in your portfolio, wherever they came from originally.
Forgetting taxes and commissions. Say your 100 shares of a $20 stock go up to $22, so you believe you’ve made a 10% profit. However, when you figure in commission, your shares really cost more like $2,050. If you sold for a $50 commission, you’d get $2,100—a 5% gain, pretax, that makes the simplicity and safety of bank CDs look good. Miscalculating this way makes it difficult for you to choose well among competing investments. Get an accurate idea of the tax and administrative costs of your investment when figuring your gains and losses.
Failing to diversify. All your life, people have warned you against putting all your eggs in one basket. You no doubt understand the concept and believe it. But note this amazing fact: Many investors still put all their eggs in one basket. They tend to invest in clumps of things, thinking in terms of individual investments rather than in terms of industries. A carefully researched portfolio of auto industry and airline stocks could all suffer losses at the same time by some common transportation problem such as increased fuel costs. A portfolio consisting of a diverse list of stocks could still lose value if it isn’t balanced by certificates of deposit or other investments that will protect you if stock prices decline sharply.
Losing patience. It’s normal to feel let down when nothing much happens to your stocks right away. Don’t lose heart, though. Make an investment not on the basis of a stock’s performance over a few months or even a year. With a long-term outlook, if you selected the stock carefully and the fundamentals remain sound, hang in.
Buying a penny or microcap stock. These are low-priced, not widely owned and not traded on any stock exchange. True, a $1,000 investment in a $1 stock gets you 1,000 shares. If the stock goes up a quarter, you’ve got a 25% profit. A little bit of this kind of speculation with money you can afford to lose might result in a big payoff. But the fact is, a dirt-cheap stock price is more likely a tip-off to a troubled company than to an undiscovered Microsoft.