There's plenty of advice on what to do - but there's not nearly as much said about the common pitfalls every investor should AVOID. Here are 10 deadly sins to watch out for:
1. Trusting an unknown stock broker. When some slick guy calls and promises to double your money in 90 days, there is only one response: hang up. While the go-go days of the 1990s are over, there are still enough small-firm cowboys out there trying to get their claws on your money. I'm not saying they're all conmen; most are perfectly legit professionals. But in order to deliver the fantastic results they talk about, they must take enormous risks - with your money, that is. They get their commissions whether you strike it rich or end up in the poorhouse.
2. Not doing your homework. There are thousands of publicly traded companies out there, and it would be folly to try and track them all. Zero in on a handful, no more than a dozen, and learn the nuts and bolts of the company. Warren Buffet likens the process to reviewing the company as if you were to buy it all rather than just a few hundred shares. Only buy something that you're comfortable with.
3. Speculating rather than investing. If you're listening to 'hot tips' and buying stock in companies you don't know just because they seem to be on a tear, you're not investing; you're speculating. This is more gambling than anything else, and it works pretty well in good times when the tide lifts all boats. Unfortunately, it's a recipe for disaster when things turn sour, as any day trader who lived through the 2000-2002 Nasdaq marathon massacre can testify.
4. Letting greed trump common sense. Let's say you've bought stock in a solid company that you know well. Then the price doubles, and doubles again. The analysts are raving about it and the CEO becomes a business magazine cover story, so you figure there's a good chance it could keep going up. However, since you know the fundamentals, you can clearly see that expectations are far ahead of reality. Since the market eventually and inevitably adjusts any stock price to reality, you should sell as soon as your gut tells you the stock is overvalued. Celebrate the excellent returns and don't fret if the price climbs a little higher before it comes crashing down.
5. Letting fear trump common sense. This is the flip side of the previous point, where the solid company gets hammered along with all the other companies in its sector. If a stock was a good enough to buy 6 months ago and the fundamentals remain good, it should be twice as good now that it is on fire sale. Unless the industry itself is about to come to an abrupt end, you should snap up the shares when everybody else panics. As reality catches up and the stock rebounds, you'll be sitting pretty.
6. Hanging on to losers. So you bought a high-flier near the peak only to ride it all the way down into the doldrums. That's not an automatic sale-signal in itself, but if the fundamentals tell you that the company is going to stay down quite a while, you may be better off cutting your losses and at least salvage the tax write-off. Waiting and praying that a tech stock 90% off its peak value will regain its former shine is a waste of time; that money could be better invested in a company with good growth prospects today.
7. Judging investments by past performance. If a stock or a mutual fund has gone through the ceiling for 3 straight quarters, it doesn't mean it's an automatic buy. In some cases it is indicative of a genuine winner - in that case, purchase to your heart's delight! - but more often than not it only means that it is overvalued. Mutual funds, which have a broader scope, have a hard time hitting that kind of out-of-the-park returns without taking on substantial risk. You don't want to be on that roller coaster when the fund manager's luck runs out and the bold bets become big duds.
8. Failure to track reports. What good is identifying a good company if you ignore subsequent quarterly and annual reports? You've got skin in the game, so it is in your best interest to study everything your company does to make sure there is no trouble on the horizon. This includes everything from financial statements to subtle hints such as the entire executive board suddenly unloading all their shares.
9. Listening to the experts. There are few unbiased stock analysts out there, and the minority who do provide useful, honest, and in-depth analysis either don't share their data with you, or they get completely drowned out by the hucksters. Ask yourself why it is so rare to see a "sell" rating for even bad companies when almost everything else is rated either "buy" or "strong buy". Something is off-balance, and it doesn't make for good decisions.
10. Not studying the fee structure. If you have a stock broker, especially a full-service broker, you should be very attentive in this regard. What good is 14% return if the combined fees for all that frenzied trading gobbles up more than half? In that case, you might as well save yourself the grief and park the dough in a safe and tax-free muni bond fund instead! Even if your broker is reasonable it never hurts to ask about lower rates. If you have some capital and a long history with the broker, odds are they may be willing to trim their cut a little.
