Stocks have been on a tear since Donald Trump's election. And the bull market celebrates its eighth birthday this week. But even in a market that goes almost straight up, it's important to avoid pitfalls. Here are some mistakes I've watched investors make repeatedly. Alas, I've made a few of them myself.
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1. Getting spooked by the bears
There are always solid reasons why the stock market should go down. Some of the smartest people I know are almost always bearish. But I think the investors who do best in the market tend to ignore many of the bearish indicators and, instead, stick to their long-term stock allocations. Over time, the market has gone up about two of every three years, on average -- and that's going back more than 100 years. You have to have a powerful reason to bet against those odds.
2. Ignoring fund volatility
In a bull market, taking extra risk generally pays off. But in bear markets, high volatility amplifies your pain. What's more, academic studies have shown that risk-adjusted returns are more predictive of future returns than raw returns. You can find risk-adjusted fund returns at Morningstar.com. Just click on 'Ratings and Risk," and look at standard deviation -- which measures the volatility of a fund's monthly returns over three, five and 10 years -- and Sharpe ratio, which measures the risk-adjusted returns over those same periods.
Consider one of my mistakes. Bridgeway Aggressive Investors 1 (BRAGX) used to be one of my favorite funds. But in the 2007-2009 bear market, it tumbled 64.4%, compared with a 55.3% loss for Standard & Poor's 500-stock index. The fund has done well again lately, returning an annualized 14.8% over the past five years, an average of 0.8 percentage point better than the S&P 500. But Bridgeway was 35% more volatile than the S&P over the past three years, and I would prefer not to risk outsized losses in the next downturn. (All prices and returns in this article are through March 8.)
3. Paying too much
I love Amazon.com (AMZN). I've practically ceased going to stores because it's so much easier and less expensive to just click a few buttons. I read books on a Kindle and watch Amazon video. It's not the stock's price, $851, that scares me. It's that the shares trade at 110 times the company's estimated earnings for the coming 12 months. That's more than six times the price-earnings ratio for the overall market. Yes, I know that the company is still growing like a weed and that the narrow profit margins on its main businesses should widen, eventually. But the shares already reflect a ton of good news. For the stock to continue higher, it will have to do even better than investors expect. I'm passing on Amazon at this price.
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4. Paying too much (part two)
It's true that for a lot of things, you get what you pay for -- meaning, high quality usually comes with a high price tag. But in investing, you generally get what you don't pay for. Study after study has come to the same conclusion: The higher a fund's expense ratio, the lower its return is likely to be. The average U.S. open-end mutual fund charges 1.2% of assets in expenses annually. But lots of index funds--both exchange-traded and mutual -- cost less than 0.1% per year. Any high-priced fund starts with a huge disadvantage. Some exceptional funds manage to overcome that hurdle, but cheaper is usually better.
5. Following the gurus
Don't confuse a spectacular long-term record with an ability to forecast the future. Investor George Soros lost nearly $1 billion when he bet that the stock market would tank following Donald Trump's election. The experts, unfortunately, often get it wrong. Ignore prognostications from the pundits, including the people I interview for this column, unless they demonstrate sound reasons for their conclusions. Even then, take what they say with a grain of salt. No one knows which way the market will head next.
6. Leaving everything up to an adviser
There are good reasons for investors to use a financial adviser, but all investors should take the time to understand the market. It really isn't that complicated. There's nothing important in investing that requires more than simple arithmetic. But that doesn't stop investment firms from coming up with complex and confusing products. Many of the mistakes I've made have come from investing in things I didn't fully understand. Moreover, if you understand the basics, it's a lot easier to keep your adviser honest.
7. Holding on to a winner too long
A stock's rise tells you where it has been. It doesn't say a thing about how it will behave in the future. That seems obvious, but as with so much that goes wrong in investing, our emotions lead us astray. Trying to tell someone to sell an investment that has done well is often very difficult. I know the glow you feel when you've watched a stock you own skyrocket. But the higher a stock, a fund or the market goes, other things being equal, the more expensive it gets and the bigger the risk of a change in direction.
8. Waiting too long to sell a loser
This is the flip side of the previous mistake. Numerous studies have shown that investors tend to sell their winners too early and hold onto their losers too long. The reason: It's exceedingly painful to realize a loss, and as long as you hold onto a stock, you can delay that pain. My advice: If you wouldn't buy a stock today, sell it, now, and move on.
Steve Goldberg is an investment adviser in the Washington, D.C., area.
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Copyright 2017 The Kiplinger Washington Editors