Don’t Make These Investment Mistakes, Part 2

“Individual investors tend to invest in a small number [of stocks] and they don’t know how to construct a portfolio. Professional portfolio managers control risk.” Jim Peterson, vice president at the Schwab Center for Financial Research.

My last post discussed the basic stock-bond allocation decision. This is a technique that many investment advisers use, but it is not the way most people approach investing. Most people are looking for an idea, a story or concept that they can build upon to make a winning investment, something that captures their imagination. They want to be a part of the next big thing, discovery or cure.

From time to time, a friend or acquaintance will tell me his or her investment philosophy. Years ago, one such friend offered the advice that you should “buy what you know.” That, of course, assumes that familiarity translates to good investment analysis. Unfortunately, there is no evidence that this is always the case.

Take, for example, people in Rochester, N.Y., who over-weighted their portfolios with Eastman Kodak and Xerox – more’s the pity for their retirement accounts. I submit that where you live (or where you grew up or where you work) should not be the guiding factor to which stocks you buy. Suppose you had lived in Houston and bought a ton of Enron stock or lived in Charlotte and invested heavily in Wachovia Bank stock?

Another past story line I’ve heard was “buy dominant technology companies with market power” as in Cisco, Microsoft, and other highflying tech stocks. That bit of advice was proffered in 2000, incidentally, just before all those “dominant technology companies” tanked.

More recently, a friend said that he liked GE, simply because Warren Buffett had invested in it. (And Buffett must know what he is doing, after all.) Fine, but Mr. Buffett’s company bought preferred shares with powerful guarantees and plenty of sweeteners; a much better deal than you or I or any “ordinary” investor will ever get buying GE common stock on the open market.

Some people follow trends, buying what “is going up” (which really means buying what has already gone up; granted, a small difference in interpretation, but a big difference in results). A good example of this is gold, which I have been asked about recently. (I’ll write more about gold in a future post.)

And, naturally, I’m also approached by the pessimists, who talk only of deficits, higher taxes in 2011 or 2012, third world debt, possible terrorism, etc., etc.

What is to be made from all these divergent concerns and predictions? In my opinion, not much. Hot tips and stocks with a good “story” or narrative are not necessarily going to reward you as an investor, because you cannot get the past performance that you have already witnessed.

Conclusion

My approach has always been and will continue to be this: If you are an investor, then you should invest. You should not allow yourself to be influenced by the news – good or bad – or by what your friends are doing or not doing. Investing is about cost control, having a globally diversified portfolio (preferably one holding thousands of securities), and taking the amount of risk that is right for you.

It is simple, but it is not easy.

To be continued…

About the author

Roger Streit, CFP®

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