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Resources
5
Investing Statements That Make You Sound Stupid
by
Amy Fontinelle
Some
people love to talk stocks, and some people love to laugh at
those people when they try to sound smart and important but
they don't know what they're talking about. If you want to be
a part of group No. 1 and avoid being the brunt of the jokes
from group No. 2, you've come to the right place. This article
will help you sound knowledgeable and wise while talking about
the market. Here are five things you shouldn't say, why you
shouldn't say them and what an experienced investor would have
said instead.
Statement
No. 1: "My investment in Company X is a sure thing."
Misconception:
If a company is hot, you'll definitely see great returns by
investing in it.
Explanation:
No investment is a sure thing. Any company can have serious
problems that are hidden from investors. Many big-name companies
- Enron, WorldCom, Adelphia and Global Crossing, to name a few
- have fallen. Even the most financially sound company with
the best management could be struck by an uncontrollable disaster
or a major change in the marketplace, such as a new competitor
or a change in technology. Further, if you buy a stock when
it's hot, it might be overvalued, which makes it harder to get
a good return. To protect yourself from disaster, diversify
your investments. This is particularly important if you choose
to invest in individual stocks instead of or in addition to
already-diversified mutual funds. To further improve your returns
and reduce your risk when investing in individual stocks, learn
how to identify companies that may not be glamorous, but that
offer long-term value.(To learn about other "sure things" that
went bad, read The Biggest Stock Scams of All Time.)
What
an experienced investor would say: "I'm willing to bet that
my investment in Company X will do great, but to be on the safe
side I've only put 5% of my savings in it."
Statement
No. 2: "I would never buy stocks now because the market is doing
terribly."
Misconception:
It's not a good idea to invest in something that is currently
declining in price.
Explanation:
If the stocks you're purchasing still have stable fundamentals,
then their currently low prices are likely only a reflection
of short-term investor fear. In this case, look at the stocks
you're interested in as if they're on sale. Take advantage of
their temporarily lower prices and buy up. But do your due diligence
first to find out why a stock's price has been driven down.
Make sure it's just market doldrums and not a more serious problem.
Remember that the stock market is cyclical, and just because
most people are panic selling doesn't mean you should, too.
(To learn more read, What Are Fundamentals? and Buy When There's
Blood In The Streets.)
What
an experienced investor would say: "I'm getting great deals
on stocks right now since the market is tanking. I'm going to
love myself for this in a few years when things have turned
around and stock prices have rebounded."
Statement
No. 3: "I just hired a great new broker, and I'm sure to beat
the market."
Misconception:
Actively managed investments do better than passively managed
investments.
Explanation:
Actively managed portfolios tend to underperform the market
for several reasons. Here are three important ones:
| 1 |
Whenever you make a trade, you must pay a commission. Even
most online discount brokerage companies charge a fee of
at least $5 per trade, and that's with you doing the work
yourself. If you've hired an actual broker to do the work
for you, your fees will be significantly higher and may
also include advisory fees. These fees add up over time,
eating into your returns. |
| 2 |
There is the risk that your broker might mismanage your
portfolio. Brokers can pad their own pockets by engaging
in excessive trading to increase commissions or choosing
investments that aren't appropriate for your goals just
to receive a company incentive or bonus. While this behavior
is not ethical, it still happens. |
| 3 |
The odds are slim that you can find a broker who can actually
beat the market consistently if you don't have a few hundred
thousand dollars to manage. |
Instead
of hiring a broker who, because of the way the business is structured,
may make decisions that aren't in your best interests, hire
a fee-only financial planner. These planners don't make any
money off of your investment decisions; they only receive an
hourly fee for their expert advice. (To learn more, Understanding
Dishonest Broker Tactics and Words From The Wise On Active Management.)
What
an experienced investor would say: "Now that I've hired
a fee-only financial planner, my net worth will increase since
I'll have an unbiased professional helping me make sound investment
decisions."
Statement
No. 4: "My investments are well-diversified because I own a
mutual fund that tracks the S&P 500."
Misconception:
Investing in a lot of stocks makes you well-diversified.
Explanation:
This isn't a bad start - owning shares of 500 stocks is better
than owning just a few stocks. However, to have a truly diversified
portfolio, you'll want to branch out into other asset classes,
like bonds, treasuries, money market funds, international stock
mutual funds or exchange traded funds (ETF). Since the S&P 500
stocks are all large-cap stocks, you can diversify even further
and potentially boost your overall returns by investing in a
small-cap index fund or ETF. Owning a mutual fund that holds
several stocks helps diversify the stock portion of a portfolio,
but owning securities in several asset classes helps diversify
the complete portfolio. (To get started, read Diversification
Beyond Equities and Diversification: It's All About (Asset)
Class.)
What
an experienced investor would say: "I've diversified the
stock component of my portfolio by buying an index fund that
tracks the S&P 500, but that's just one component of my portfolio."
Statement
No. 5: "I made $1,000 in the stock market today."
Misconception:
You make money when your investments go up in value and you
lose money when they go down.
Explanation:
If your gain is only on paper, you haven't gained any money.
Nothing is set in stone until you actually sell. That's yet
another reason why you don't need to worry too much about cyclical
declines in the stock market - if you hang onto your investments,
there's a very good chance that they'll go up in value. And
if you're a long-term investor, you'll have plenty of good opportunities
over the years to sell at a profit. Better yet, if current tax
law remains unchanged, you'll be taxed at a lower rate on the
gains from your long-term investments, allowing you to keep
more of your profit. Portfolio values fluctuate constantly but
gains and losses are not realized until you act upon the fluctuations.
What
an experienced investor would say: "The value of my portfolio
went up $1,000 today - I guess it was a good day in the market,
but it doesn't really affect me since I'm not selling anytime
soon."
Conclusion
These
misconceptions are so widespread that even your smartest friends
and acquaintances are likely to reference at least one of them
from time to time. They may even tell you you're wrong if you
try to correct them. Of course, in the end, the most important
thing when it comes to your investments isn't looking or sounding
smart, but actually being smart. Avoid making the mistakes described
in these five verbal blunders and you'll be on the right path
to higher returns.
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