By Kelly Marshall
That was really hard to do during the period of mid to late 1998 until the meltdown of March of 2000. During that time everybody who invested made money. Well, everybody did… until they didn’t anymore.
Historically, returns on stocks are about seven percent. That’s a hard sell for a young twenty-five year old professional. Because you do have so much of your working life ahead of you, you can afford to be more aggressive but still the losses you are bound to take keep you pretty much locked into historic averages. It’s just so easy to be optimistic, or to feel in control when control doesn’t really exist, leading to poor choices with real money. Here are a few.
New investors hunting for home runs often turn to penny stocks believing they are an easy way to double their money. People see a stock trading at five cents a share and actually expect that stock to go up to ten or fifteen cents a share in a few weeks or months, doubling or tripling their money. They reason that for the stock to go from five cents to fifteen it “only” has to go up ten cents. Technically, they are right, but that reasoning is flawed.
For that stock to go from five to fifteen cents, it has to triple in value. How likely is that really? That’s almost like expecting Cisco to go from 15 to forty-five in a few months. You have to understand what it would take to drive Cisco up that much. It would have to smash earnings expectations and reinvent the wheel and discover the cure to cancer. So why should your penny stock go up so much easier? It’s true that it is easier for a penny stock to go up faster because the amount of outstanding shares are a fraction of Cisco’s float, but gains like doubling or tripling your investments that fast are highly unlikely.
What’s worse, penny stocks are more likely tied to much smaller companies that are inherently less stable than a Cisco, and are also more easily manipulated. If you’re going to invest in a stock, it should be because to realize returns because the company grows, not because people are playing games with the shares. Those kinds of games easily cut both ways.
Even veteran investors can be suckered into following the next hottest tip at times. It’s those hot tips from your dentist/plumber/doctor/anybody but yourself, that often brings new investors to the market that might not otherwise be investing. And if you’re following some hot tip you’re not investing — you’re gambling.
The truth about hot tips is this: By the time you hear about it, the advantage you thought you’d get has already been priced into the stock. So the next time you hear that Cisco is going to buy out that little networking company your plumber knows about, the stock has already gone up in reaction to the rumor. You’re too late.
Remember, investing involves research, strategy and using common sense. Wall Street firms employ armies of analysts who work very hard to know everything that’s going on with just a few companies in an industry. They don’t have other jobs– just that singular focus. Are you privvy to something they aren’t? What makes you think so? Following the hottest tip is a fool’s errand. You might as well go to Vegas and bet against the house. See how far that gets you.
Failing to understand what diversification is, is another biggie. Owning five banking stocks is not diversification. If one of those banks misses earnings numbers you’re going to find that the other six banking stocks you own are going to tank in sympathy; something like changing rooms on the Titanic comes to mind.
Back in the very late 90s, no one would diversify out of tech stocks. People thought that if they owned ten different tech stocks, they were diversified. They found out just how wrong they were as the bubble burst.
Why don’t people want to diversify? Often it’s a lack of understanding, but in high growth phases (and especially bubbles) it’s a fear of under-performing the market. Some investors will actually move to brokers who have no qualms concentrating their portfolios to maximize returns right now, never asking about what happens when the run is over.
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Diversifying means buying across several sectors like banking, oil and energy, health care, transportation, basic materials, etc. That way, if something is going down, you’ve probably got something that’s going up; it all balances out.
The most diversified stock portfolios often include the humble index fund; insurance that you will only ever perform as well, or as bad as the entire stock market. That isn’t a bad bet!
No Consistent Plan
Having time on your side is both a blessing and curse when it comes to investing. Typically strapped for cash, most young people delay investing, when even a few dollars a month could make a dramatic difference in their wealth 30 or 40 years later. Compound interest is a beautiful thing. And so is dollar-cost averaging, which means you consistently buy stocks, whether they’re going up or down. No one has ever figured out how to time the market, and you won’t either. But if you buy all the time, you’re always getting a fair deal and making out in the long run.
You can benefit from both compounding interest and dollar-cost averaging by setting up an automatic withdrawal from your paycheck or bank account. If it’s from your paycheck as part of a 401(k) plan, that could mean matching funds from your employer, which literally equates to free money!
“Investment Grade” Consumer Goods
If you’re making good money for your age, it can be tempting to show it, and if that’s something you want to do, more power to you. However, don’t think for one second that an expensive luxury item is in ANY way an investment. It’s just overhead. Don’t believe me? Just try to turn that Rolex or other jewelry into cash. You’re not going to get even close to what you paid for it. And that fancy car? After you account for the maintenance and those insurance rates, how much will owning it net you, as an investment? No one thinks buying a car is a money making pursuit, so why call it an investment?
Avoid the allure of cheap stocks just because they’re cheap, forget about chasing after the latest hottest stock tip, diversify your holdings, and chart a consistent path that doesn’t include “investing” in stuff that is expensive to maintain and only loses value. Do these simple things, and you’re already smarter than most novice investors… and many experienced ones, too.
Kelly Marshall writes for many sites that help you buy auto insurance online. These sites provide useful information and tips for saving on auto insurance.
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