Stocks: Five Market Mistakes to Avoid
Despite a rally, these remain tricky times for investors. Pros tell how to sidestep potential pitfalls for your portfolio
By Ben Steverman
Markets may have rebounded in 2009, but individual investors are still edgy and shell-shocked.
Even as the broad Standard & Poor's 500-stock index remained up 56% since March, the U.S. unemployment rate crept above 10%, according to a Labor Dept. report released Nov. 6. "I don't think many people are feeling very relieved," says Milo Benningfield of Benningfield Financial Advisors in San Francisco. Many people believe the "[stock market rally] can't last," he says.
These remain risky times, and the last few years have demonstrated to investors the high cost of doing the wrong thing. Against that nervous backdrop, BusinessWeek asked financial advisers what common mistakes investors are making, and how to avoid them:
1. Don't Jump In All at Once
A little optimism can be a dangerous thing. Individual investors are notorious for selling stocks when markets have already dropped and buying after they have risen. And, says Susan Elser of Elser Financial Planning in Indianapolis, "Selling low and buying high is the worst thing you can do for your returns."
Among those who stayed away from stocks and other risky investments for the past year, many are irked to have missed out on the recent rally. But is now the right time to buy again?
Don't rush back into the market because you worry you've missed the rally. "The biggest mistake is [to try] to make everything up at once," says Micah Porter, president of the Minerva Planning Group in Atlanta.
At these levels, a 10%, 15%, or 20% correction in the stock market is entirely possible at almost any time. So, instead of buying all at once, Porter advises buying stocks gradually over the next year—or, if you have a lot to invest, an even longer time frame. That puts you in the market long-term, but minimizes the chances you'll buy at the market's exact peak.
2. Don't Fall for Fads or Hype
In investing, jumping on the bandwagon is often a bad idea.
For example, television ads have appeared touting gold as an investment after the precious metal's price has jumped higher, approaching $1,100 per ounce on Nov. 6.
Yet this could be the very time when gold prices are at or near their peak. "This is probably the worst time in my opinion to pile into gold," Benningfield says. He also warns against currency speculation, another recent fad. "It's really risky," he says.
Along with other commodities, gold can be a valuable part of investment portfolios. But advisers like Steve Medland of TABR Capital Management in Orange, Calif., suggest keeping gold to less than 5% of your holdings.
Lots of marketing dollars are also pushing equity-indexed annuities these days. "It is the hot product of the day," Elser says. But Elser, Medland, and others warn about the complexity and high fees of these annuities.
3. Don't Use Headlines or Politics as Investing Guides
"Making [an investing] decision based on who is in political office, whether you agree or disagree, is a huge mistake," says Elaine Scoggins, client experience director at Merriman, a Seattle-based investment advisory firm.
Since the election of Barack Obama as President, political temperatures on the right have risen (just as tempers rose among liberals during the last Administration). And that could be leading to bad investing decisions.
Based on their political beliefs, people are buying into disaster scenarios, from high inflation to a crash for the U.S. dollar to skyrocketing tax rates, Scoggins says. "There are a lot of scare tactics in the media and in politics."
Betting your portfolio on these unlikely outcomes can be a big mistake.
"There's incredible fear out there," says Paul Sutherland, chief investment officer at FIM Group in Traverse City, Mich. But not all the fear is warranted. For example, he notes, a weaker dollar actually can help U.S. manufacturing or U.S. firms with overseas profits.
Politics and current events tend to spark emotions, which are a poor guide for long-term investing, Medland says. "What's going on in the headlines doesn't predict what is happening in the markets," he says.
However, one political fact investors should be aware of is the likelihood of higher taxes for wealthier Americans. Though it's hard to know when and how much rates will increase, good financial advice can help taxpayers minimize their tax bills in some cases. For example, Americans might take investment gains now, while capital gains rates are still relatively low.
4. Don't Disregard Quality
Since March, the lowest-quality companies have had the best-performing stocks. Punished in the depths of the financial crisis, they have rebounded on hopes of a recovery. For example, banks, industrial firms, or very small companies—i.e., risky firms highly influenced by the financial crisis and the recession—have seen their shares double or triple in price.
Meanwhile, companies with stable, consistent businesses have often languished in the stock market.
Don't expect that trend to continue. In fact, the trend may have already ended.
Consider the firms that have done best over the last 12 months in boosting revenue. According to Capital IQ, the top 100 revenue-raisers in the S&P 500 are up a median of 50.3% since the March low, while the firms with the 100 worst 12-month sales-growth records have rocketed higher by a median of 96.7%.
In the last month, though, the performance between the two groups began evening out, and in the past week the trend has reversed entirely. In the first week of November, the median quality firm is up 0.6%, while the median worst firm is actually down 0.2%.
John Merrill, chief investment officer at Tanglewood Wealth Management, says the shift may be the result of a new kind of investor entering the market. These stock managers have been cautious for months, but now they believe they need to start buying. Still wary of risk, "They're going to take the safest step into the market," Merrill says.
Firms with strong fundamentals also can be more resilient long-term bets and may be selling at cheaper prices after the recent rally, Sutherland says. "There are a lot of quality companies selling at great prices," he says.
The same may be true in the bond market. Porter warns against buying high-yielding junk bonds after an "incredible run" for the risky investments.
5. Don't Forget What You Learned
The sudden drop in stocks in 2008 and early 2009 taught every investor what can go wrong. Financial experts say these lessons shouldn't be forgotten, even amid a stock market rally.
"People should always be thinking about those worst-case scenarios," says Medland. The biggest mistake in a crisis, he says, is to not have a plan in advance.
The crisis also taught investors something about themselves, about their ability to invest for the long-term without selling low and buying high.
If you panicked in March and sold all your stock, you've lost out on big gains. If you're susceptible to such investing mistakes in times of crisis, maybe you should pursue a more conservative strategy, Elser says.
"People who jump in and out of the market probably shouldn't be in the market," Elser says. "You either have that tolerance for volatility or you don't."
For many investors, "one lesson is maybe they took on too much risk," Benningfield says.
Against the backdrop of a tough job market, investors are desperate for returns from their investments. They're still smarting from huge holes in their portfolio caused by the market meltdown. But it's important to remember: If you lost big on risky investments in 2008 and early 2009, the solution is not to take on even more risk in an attempt to win back your losses.
