7 Investment Traps

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For years now an industry writer publishes his annual lists of Don’ts for investing. He changes a couple every year. I took these and put together a list that I regularly go over to make sure both my clients and I are not falling into these traps.

1. Confusing good ideas with good investments

Sometimes advisors and clients will overuse a product or service—think social media or online gaming—and immediately classify it as a can’t-miss investment.

  1. The first mistake is usually the assumption that they are early to the game and have caught something the rest of the investing public has missed.

  2. The next mistake is extrapolating personal usage into expectations for more widespread popularity.

  3. The third error is expecting wider product adoption to naturally translate into financial statement profitability.

  4. Lastly, even profitability does not guarantee an attractive investment because the shares may have been overpriced from the early stages

2. Reaching for yield

I have written about this quite often over the last few years. The whole investment world has been buying stocks with good yields, pushing the price up, and the yield down. Just because you want more yield don’t get into riskier investments to get a higher yield. A yield over 7% in this market tends to be a warning sign. A few extra points of yield earned over a year can disappear in minutes when markets and the investment drop. There is usually something much safer available at a slightly lower yield.

3. Falling in love with the story

If you fall for the story behind a company, its product or the management, you may not see fundamental flaws, poor market conditions or overpricing of the stock. Instead, recognize that executives talk to advisors to sell their company as an investment. They go on the business news stations to bring this to the public. Marketing experts agree the best sales job is achieved through telling a story and not by talking numbers and facts. Stories get you emotionally invested, far beyond what plain facts could ever do. It’s easier for management to address changes or setbacks in the story than it is to talk about missed numbers. I have seen too many advisors and clients fall in love with the story and not know when to get out.

4. It’s different this time

We hear this every time we have a bull market or a sector or stock runs too far. Believing you stumbled on something new or different in the investment world can get you in trouble. Simply put, it’s never different. The rules of successful investing never change. Stick to the tried and true. Nobody ever went broke by steering clear of new kinds of investments, especially anything that reeks of financial engineering.

5. Doubling down

This one drives me nuts. Doubling down is when investors are determined to break even on a particular investment. When a stock takes a hit because of bad news, you are faced with two choices: sell the name because more bad news may be coming (called the cockroach theory) or double up on the number of shares owned so that even a halfway rebound will bring the investment back to par.

This is pure psychology at work. There is almost always a better investment alternative (with better upside) than the wounded stock in hand. The hard part is having to admit you lost before moving on and making it back on a different stock with better potential. So learn to let go. Growing your portfolio in tantamount, not showing that stock who’s the boss.

I review far too many portfolios that are laden with losers that the investor won’t sell until they make their money back in that investment: A perfect way to kill your portfolio return. Our goal is to grow your net worth.

6. Focusing on the near term or Riding a winner too long

There are major forces that drive advisors and investors to focus on short-term investment horizons. The vast majority of investment research is based on a 12-month outlook, and portfolio performance is measured on a quarterly, if not monthly, basis. Because of this, getting the timing right is half the challenge when it comes to investing. Nevertheless, there are times when quality stocks get beaten down by the market for various reasons. All you need is a patient hand to guide you.

On the other hand, holding winning stocks for too long can be just as costly as sticking with losers. It’s hard to argue against booking gains. You never lose money when you book a gain.

7. Remember:

  • Following rules is investing.

  • Following emotions is gambling.

If you want to see what a truly independent advisor can do for you, call me at 905-846-9060, ext.3838, email me at Terry.McIntyre@manulifesecurities.ca or visit my website at www.terrymcintyre.ca