5 Mistakes New Investors Often Make
If only I knew then what I know now. It's a common refrain, and while nobody can avoid making mistakes in life, investing is one of those areas where there are some well-documented whoppers novices often make. Of course, some mistakes are extremely well-documented. We've all heard that we should diversify investments, over and over. But what about some of the lesser-known ways rookie investors frequently lose their shirts? We sought out some investment experts to see what they felt are some less well-known traps early investors catch themselves in.
Buying stock in a bankrupt company. At first glance, that sounds crazy, but to some investors, crazy like a fox. After all, a well-established company that has bottomed out has nowhere to go but up, right? Especially if it's a well-known company that will continue in business. And especially because "it's not unusual for stocks of companies that once boasted market caps in the billions to trade for pennies per share in the [over-the-counter] markets post-bankruptcy," says Patrick Larkin, a professor of finance at Fayetteville State University in North Carolina.
"But the reason that the shares become so cheap is that the odds are overwhelming that the common stock of a bankrupt company is going to be 'extinguished' by the court," Larkin says. "After all, companies typically file bankruptcy because they can't pay their debts. If there were enough resources available to pay creditors and still have something left over for shareholders, then the company most likely would have been able to avoid filing bankruptcy in the first place."
Being overly influenced by recent events. Yes, a company may be getting a lot of press and praise for its stock value, but that doesn't necessarily bode well for every shareholder in the long run.
"Rookie investors sometimes look at trailing returns of mutual funds and assume that the best-performing funds are good funds and are likely to repeat going forward," says Jim Scheinberg, managing partner of North Pier Fiduciary Management, a Los Angeles asset-management firm that specializes in retirement plan consulting.
"The reality," Scheinberg says, "is the best-performing funds from last year frequently don't repeat next year."
They may, of course. But just as often, he says, a fund had its moment in the sun, and now normalcy is setting in.
"What is best is for new investors to seek long-term good performers that didn't just have a great last year but consistently have returns that rank in the top half of their peer group measured over a long period of time," Scheinberg says.
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Echoing that sentiment is Bill DeShurko, a portfolio manager on Covestor.com, an online marketplace for investing. He says far too many new investors find themselves looking for the next hot thing. "Investors need to understand that by the time they recognize a trend, the easy money has been made. It's much better to look at proven long-term strategies and stick with them," DeShurko says.
Holding onto losers. You hear all the time that you need to invest for the long haul and be patient because generally, over the years, the stock market goes up, and that's true. But it's also true that you don't want to hold onto a company's stock if it's evident that the stock is crashing and will never return to its once-former glory, according to Larkin.
Some investors, Larkin says, "fail to sell when the facts change, irrationally hoping to 'get back to even' when they are down."
Failing to research a new investment. Doing your homework before investing in a stock or fund sounds logical, and it's something everyone has heard a million times. But many investors don't do that - or don't research enough, says Tim Wilson and Ajit Singh, partners at Artiman Ventures, a "white space" investment firm in East Palo Alto, Calif. (By white space, they specialize in new industries and markets.)
For instance, Wilson says he once fell hard for a company and asked for the organization charts - which was extremely diligent of him. But he didn't think to ask if the names of the people in the company were related.
"Turns out, I was dealing with an internal syndicate of husband-wife-cousins-brothers with different last names all bonded by blood - not objectivity," Wilson says. "When the company turned south, selective surgery was impossible, and the board ended up amputating multiple limbs. We were dead either way."
Singh adds to that line of thinking, saying that a company having an incredible idea for a product or service isn't enough. An investor should consider the environment in which the business will be trying to produce the next great thing.
"Very often, it's the attributes of the ecosystem that will affect the success of the company - how difficult it will be to scale, how long it will take and how likely it will be cannibalized," Singh says.
Forgetting your company's retirement plan. Cary Guffey, a financial advisor with PNC Investments in Birmingham, Ala., says he sees this a lot - people getting excited about the vast array of investments out there but forgetting about their company's seemingly boring retirement plan.
"Most companies have reinstated matching, so not participating is leaving free money on the table," Guffey says. "Put another way, if you have a company that matches dollar for dollar up to 3 percent, built-in, you have a 100 percent return on your investment."
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