Preventing Investment Mistakes: Ten Risk Minimizers
Most investment mistakes are caused by basic misunderstandings of the
securities markets and by invalid performance expectations. The markets
move in totally unpredictable cyclical patterns of varying duration and
amplitude. Evaluating the performance of the two major classes of investment
securities needs to be done separately because they are owned for differing
purposes. Stock market equity investments are expected to produce realized
capital gains; income-producing investments are expected to generate cash
flow.
Losing money on an investment may not be the result of an investment
mistake, and not all mistakes result in monetary losses. But errors occur
most frequently when judgment is unduly influenced by emotions such as
fear and greed, hindsightful observations, and short-term market value
comparisons with unrelated numbers. Your own misconceptions about how
securities react to varying economic, political, and hysterical circumstances
are your most vicious enemy.
Master these ten risk-minimizers to improve your long-term investment
performance:
1. Develop an investment plan. Identify realistic goals
that include considerations of time, risk-tolerance, and future income
requirements - think about where you are going before you start moving
in the wrong direction. A well thought out plan will not need frequent
adjustments. A well-managed plan will not be susceptible to the addition
of trendy speculations.
2. Learn to distinguish between asset allocation and diversification
decisions. Asset allocation divides the portfolio between equity
and income securities. Diversification is a strategy that limits the size
of individual portfolio holdings in at least three different ways. Neither
activity is a hedge, or a market timing devices. Neither can be done precisely
with mutual funds, and both are handled most efficiently by using a cost
basis approach like the Working Capital Model.
3. Be patient with your plan. Although investing is
always referred to as long- term, it is rarely dealt with as such by investors,
the media, or financial advisors. Never change direction frequently, and
always make gradual rather than drastic adjustments. Short-term market
value movements must not be compared with un-portfolio related indices
and averages. There is no index that compares with your portfolio, and
calendar sub-divisions have no relationship whatever to market, interest
rate, or economic cycles.
4. Never fall in love with a security, particularly
when the company was once your employer. It's alarming how often accounting
and other professionals refuse to fix the resultant single-issue portfolios.
Aside from the love issue, this becomes an unwilling-to-pay-the-taxes
problem that often brings the unrealized gain to the Schedule D as a realized
loss. No profit, in either class of securities, should ever go unrealized.
A target profit must be established as part of your plan.
5. Prevent "analysis paralysis" from short-circuiting your decision-making
powers. An overdose of information will cause confusion, hindsight,
and an inability to distinguish between research and sales materials -
quite often the same document. A somewhat narrow focus on information
that supports a logical and well-documented investment strategy will be
more productive in the long run. Avoid future predictors.
6. Burn, delete, toss out the window any short cuts or gimmicks
that are supposed to provide instant stock picking success with minimum
effort. Don't allow your portfolio to become a hodgepodge of
mutual funds, index ETFs, partnerships, pennies, hedges, shorts, strips,
metals, grains, options, currencies, etc. Consumers' obsession with products
underlines how Wall Street has made it impossible for financial professionals
to survive without them. Remember: consumers buy products; investors select
securities.
7. Attend a workshop on interest rate expectation (IRE) sensitive
securities and learn how to deal appropriately with changes in
their market value--- in either direction. The income portion of your
portfolio must be looked at separately from the growth portion. Bottom
line market value changes must be expected and understood, not reacted
to with either fear or greed. Fixed income does not mean fixed price.
Few investors ever realize (in either sense) the full power of this portion
of their portfolio.
8. Ignore Mother Nature's evil twin daughters, speculation and
pessimism. They'll con you into buying at market peaks and panicking
when prices fall, ignoring the cyclical opportunities provided by Momma.
Never buy at all time high prices or overload the portfolio with current
story stocks. Buy good companies, little by little, at lower prices and
avoid the typical investor's buy high, sell low frustration.
9. Step away from calendar year, market value thinking.
Most investment errors involve unrealistic time horizon, and/or "apples
to oranges" performance comparisons. The get rich slowly path is a more
reliable investment road that Wall Street has allowed to become overgrown,
if not abandoned. Portfolio growth is rarely a straight-up arrow and short-term
comparisons with unrelated indices, averages or strategies simply produce
detours that speed progress away from original portfolio goals.
10. Avoid the cheap, the easy, the confusing, the most popular,
the future knowing, and the one-size-fits-all. There are no freebies
or sure things on Wall Street, and the further you stray from conventional
stocks and bonds, the more risk you are adding to your portfolio. When
cheap is an investor's primary concern, what he gets will generally be
worth the price.
Compounding the problems that investors face managing their investment
portfolios is the sensationalism that the media brings to the process.
Step away from calendar year, market value thinking. Investing is a personal
project where individual/family goals and objectives must dictate portfolio
structure, management strategy, and performance evaluation techniques.
Do most individual investors have difficulty in an environment that
encourages instant gratification, supports all forms of speculation, and
gets off on shortsighted reports, reactions, and achievements? Yup.
