In early 2010, a Moscow resident, Lusha, had a stock portfolio that was able to outperform 94% of all of Russia’s mutual fund managers. Surely, Lusha is a professional investor with a lot of advanced knowledge and a who’s who of researchers on her staff, right? Actually, Lusha isn’t a professional investor at all, and in fact, she has no formal investment training.
Lusha is a chimpanzee, and her day job is riding a scooter in the circus! The primate was given one million rubles and a list of stocks to pick from. She picked eight stocks and outperformed all but 6% of the investment professionals.
Avoid Stock Market Losses! Beware Of These 5 Investment Missteps
As you know, investing isn’t so easy that a chimp can do it. And if you were to pick stocks the same way Lusha did, you would most likely lose money. In order to avoid stock market losses, we should be aware of the mistakes that are costing us money now and in the future.
Investment Mistake #1: Failure to Hold
There are two main types of players in the investment markets: Investors and Traders. Investors place money in stocks for the long term. Traders buy and sell often. Some traders hold positions only minutes or seconds but most hold their investments for days, weeks, or even months.
Statistically speaking, trading is a losing proposition for most. One study showed that 89% of professional traders lost an average of 4.5% over a 5 year period. And what about average investors who trade? Here’s more on why they may not make money in the stock market. If the pros who try to trade around the short term changes in investments often lose money, then how do you think the amateur trader will do?
Warren Buffet, widely known as one of the world’s best investors, was asked how long he plans to hold some of his investments. His answer was, “forever”. You may not hold your investments forever, but the statistics show that the longer you stay in an investment, the more likely you are to make money. If you were alive in 1950 and invested $1 in an index fund, today you would have about $625.
Many amateur investors begin investing in an attempt to harness short term gains but statistics show that most will ultimately lose money this way.
Can you do better than a dart-throwing monkey?
Investment Mistake #2: Failure to Diversify
Diversification is simply making sure that all of your investment eggs aren’t in one basket. The statistics for different stock sectors from 2007 to 2010 show us why. If you had placed all of your investment funds into the industrial metals sector (companies like Alcoa) during that time, you would have made an impressive 35%; but if you had gone all-in on the financial services sector, (companies like Bank of America), then you would have lost 9%.
Since no savvy investor wants to try and predict the one sector that would do the best, diversification allows for the investor to gain an average return of the winners and losers. Investment pros recommend that we hold stocks or exchange traded fund investments in at least 5 different sectors. Find out more on ETF investing here.
Investment Mistake #3: Failure to Capture Dividends
Remember the $625 that your $1 investment made you? 44% of that is a result of dividend payments. A dividend is simply a payment made to you for holding on to the stock much like the interest you receive from your bank. Dividends are often paid four times per year on a per share basis. Companies pay shareholders from 0% to 10% or more annually, for holding on to their stock.
There are some drawbacks to dividends. First, companies that pay dividends are often well established and don’t experience large scale gains in stock price. Second, companies can reduce or remove their dividend at any time.
While it’s not imperative that every stock in your portfolio pay a dividend, this is the easiest and safest way to make money in the stock market.
Investment Mistake #4: Failure to Place Stops
A stop is an order to sell a stock if its price falls to a certain level. Many stock portfolios depreciated quite a bit during the stock market meltdown of 2008 because investors didn’t have stops in place. You can place an order that tells your stock broker to sell your stock if it falls a certain amount. The power of a stop order is that you dictate the maximum amount of money you’re willing to lose.
Although investment professionals differ on the stop amount, many believe that setting a stop at 7% below the stock’s current price is optimal. This means that if the current value of your investment drops 7%, it will automatically be sold.
A better option is to use a trailing stop. This means that as the value of your investment rises, the stop amount will go up. If your investment gains 1% in value, the stop becomes 7% below the new price.
If you don’t know how to place a stop order, ask your brokerage firm for help.
Investment Mistake #5: Failure to Research
Jim Cramer (a professional stock investor, creator of numerous best-selling investment services and author of popular investment books) recommends that an investor spend one hour per week per stock, researching and staying up to date about any news related to the stock they are evaluating.
While holding a stock for the long term is the best way to make money, there are times when the conditions under which you decided to invest in a stock can change. Management changes, scandal, loss of dividend or changes in the industry are all reasons that might lead you to the decision to sell a stock. You must be on the lookout for these changes. Here are 20 reasons to sell your stock or mutual fund.
Are You A Stock Investor? Do It Right!
If you have committed one of these investing failures, you can still right the wrong. Start today. Evaluate your portfolio, start your research and don’t use Lusha’s investment method!
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