Custom Search

15 December 2008

5 Mistakes Investors Make

MSN posted an article on the '5 biggest investing mistakes'. While in general I can agree with the philosophies discussed during bull markets, it's a hard pill to swallow when we're going through what we are today. Granted, if you didn't get out of the market before the collapse, it may be too late to get out now. That is, if you think we're near a bottom. If you think the economy is on the verge of turning around, then now is probably a good time to buy. If you think that the economy is going to get worse before it gets better, then it may not be too late to sell your holdings and preserve your capital for even lower prices. The key is, however, you can't wait until the market recovers to where it is today to re-enter the market. You have to have a plan and determine when the risk of further economic deterioration has subsided.

The 5 mistakes MSN discusses are:

1. Panicking and Selling.

When the markets are tanking the way they did in October, most people will hope for a swift rebound then swear to sell if they can get most of their money back. But the downturn we had was bigger than most expected so investors tend to want to stop the bleeding and get out even with big losses.

MSN recommends holding your investments since your losses aren't realized until you sell. Past market downturns have eventually rebounded and in the long term you will be better off, you will recover your losses and even make money. Many investors will panic, sell low, then buy back in after the market recovers, essentially selling low and buying high.

I get this and can agree to a point. At some point, if you believe the market is not done tanking, it is not a bad idea to sell some or all of your holdings on a rebound, preserve your capital and return to the market when it looks like the economy has a chance of recovering. The markets love to suck in investors to steal their money in bear markets. This is called a suckers rally. I haven't seen anything that is screaming to me that the economy is done getting worse. The government is still bailing out corporations, unemployment is still rising, banks are still not lending, the auto industry is still on the brink of failure, etc, etc. I'm still glad that I went to cash 7 months before the stock market wipeout.

2. Tuning in Too Much.

There is a lot of information out there, on TV and the internet. People tune in and want to react to every little bit of information. One day the market is up and the next it is down. Reacting to every bit of news can kill your investments.

This information overload can cause investors to react emotionally instead of logically. I agree with this. Develop a long term plan and don't get bogged down too much with day to day stuff. Reposition your portfolio based on what your long term plan is.

3. Halting Retirement Contributions.

MSN recommends to continue contributing to your retirement plan. Many people have lost half or more of their retirement funds and don't want to throw good money after bad.

It is understandable that people are hesitant to contribute more money into a plan that is losing money at alarming rates. But you don't have to invest it in the stock market. Put your money in a money market fund or keep it in cash until you believe the economy is about to rebound and the market looks to be making a bottom, then begin to slowly invest back into the market.

4. Veering from Your Plan.

MSN says that during market downturns people will stray from the path of their long term plan. Instead of holding and waiting, investors begin to try and time the market for quick profits.

I think the long term plan is a good idea, but I think that considering downturns and readjusting your portfolio accordingly can be part of the long term plan. Trying to time the markets for quick profits is probably not a good idea for a retirement portfolio. Keep this speculative activity for a separate account. I'm not an advocate of buying stocks and not checking them again until the day before you retire, like many buy and hold advocates will tell you. Holding through downturns in a bull market when the economy is growing is fine, but holding through a downturn like we're having today is going to be costly. If you are close to retirement, it is possible that you may never recover the losses you are accumulating. Even though analysts don't like to compare this market to Japan's market in the 1990's, it is possible that, like Japan, this market could take 20 years or more to recover. Japan's still hasn't recovered after 18 years and given what's happening today, it could be another 18.

5. Holding One Basket on the Upswing.

It is important for investors to harvest cash when they have top performing stocks or funds during an upswing. Take some profits after a price increase; it is easier to sell during times of investor enthusiasm and get good prices, although greed keeps many investors from letting go of profitable trades. Also, investors should invest in a diverse cross section of the economy to take advantage of rising sectors and counterbalance sectors that aren't performing as well.

By taking profits from big winners it makes it possible to change the definition of portfolio diversity and buy investments that are more appropriate for the economic climate. Recently, as stocks plummeted, investors switched to bonds for safety. Soon they will need to re-evaluate this strategy and find the next hot sector.

Have a plan, diversify, but don't be afraid to reallocate your portfolio to investments appropriate to the economic climate. And if you fear a huge market correction, it is better to be safe than sorry. You may give up some short term gains, but you might be better off preserving capital for better opportunities. In this market, it is better to be a month late than a month early.

No comments:

Post a Comment