How to Avoid Five Common Investment Mistakes of Do-It-Yourself Investors
I've been investing in the stock market since I was 13 years old and I've been a financial advisor and financial services executive for more than 18 years. Over the years, I've learned many investment lessons- sometimes the hard way. Many people believe that investing in individual stocks is a gamble they just can't win. Without a set of rules to increase the chances of growing a portfolio, many people fail at reaching their goals when investing in individual issue stocks. Certainly many Americans invest heavily in their company's stock, but investing in individual stocks is not for everyone.
The old adage that a good offense is a good defense is true. I employ many defensive strategies when investing in individual stocks because of the inherent risk and higher volatility compared to other financial investments. When people come to us with no investment strategy or with preconceived investment beliefs that I know are potentially harmful, I advise them of five common investment mistakes to avoid.
1. Don't Hold On to the Losers: Be Prepared to Cut Your Losses
I learned about cutting losses from William O'Neal at Investor's Business Daily. This is a crucial investment philosophy. If you limit your losses to a fixed amount, then you can protect your principal. At Gerber Kawasaki we set a 15% maximum loss objective on any one stock position. By having this escape hatch, it gives our clients more confidence that we strive to not let any one company overly impact the performance of the portfolio. By cutting the losers early and letting the winners run, we try to help preserve the portfolio from suffering any large loss.
2. Don't Sell the Winners
Sell your losers quickly and focus your investments on stocks that are performing well. This strategy is similar to fielding a basketball team. If one player is missing all their shots, take him out of the game. You want the best performing players on the court. Often inexperienced investors don't want to take a loss or accept being wrong and will hold onto their losers with the hope that they will come back. Meanwhile they are missing out on the opportunity to potentially make better investments. Usually a stocks momentum continues to move in the stock in the same direction. It is easy to turn a bad investment into a disaster by watching it drop from a 15% loss to a 50% loss. We want to avoid disasters. That is the key to getting good investment results. Unfortunately many investors tend to sell good stocks too soon. They sell as soon as they have made a profit. They are prematurely happy about their profit, but they miss out on future gains and pay higher taxes on their short term profit. We believe good stocks can be held for a long time.
3. Don't Buy One Stock at a Time
Many people have portfolios that lack asset allocation and diversification. They buy one stock at a time instead of seeing their portfolio like a fantasy football team. When building a portfolio we don't want to own only a few stocks. Typically we like clients to have a minimum of ten positions and require $150,000 as a minimum investment for an individual stock account. It is actually harder to make money without proper diversification. Like a sports' team, every player on the team does not always perform the same. Having several star players on a team can potentially get you the best of many worlds: less volatility and more consistency of returns without a reduction in performance. If you own only a few stocks you are essentially betting, not investing. Betting is a 50-50 proposition at best, but building a good team of stocks is key to improving your performance.
4. Don't Pay Too Much Attention to Business Media Pundits
It is risky business to rely on the financial press or books for investment ideas. There are inherent flaws in trying to do it yourself. It is critical to assemble a team of stocks that fit the financial goals and risk tolerance of each investor or family. This requires the help of a professional. It is complicated. Books and pundits give blanket advice that may or may not be good or appropriate for all investors. Unfortunately, when you hear about hot stocks through the media, often their best days are behind them. The challenge is to own stocks before they make it to Cramer's show. The financial media has to find good ideas every day. As a professional investor it is my experience that there are approximately four or five good ideas a year that fit all of my criteria for a great investment. Managing an individual stock portfolio is really hard work. There is a reason why investing in the stocks of an index is so popular. It is a lot easier to play the odds by owning every stock but your results will be less spectacular.
5. Don't Believe that Good Companies Always Mean Good Stocks
This concept sounds counter intuitive. But many times clients get excited about a great company that they love. They want to buy the stock. Sometimes when we research the company we see that the stock is trading at a huge multiple to earnings. We advise the client that although we also love the company, we believe that it is too expensive. We teach clients that companies have a value. It is important to find the right price to invest in good companies. The challenge, of course, is to find good companies at good prices. Sometimes there are good companies that make great money and have low valuations - but they never go up in price. It is important to understand why we might not invest in these good companies when the stock never seems to go up. There might be many reasons why a stock price stays flat, but the reality is, if investors are not buying the stock, it will not go up. Often these companies are mature and do not have huge growth prospects, but people believe that current earnings drive stocks. We believe it is really the growth of future earnings that matter in moving a stock price higher.
Making good stock investments should involve an experienced investment advisor to help build your portfolio. At Gerber Kawasaki we have strict rules, experience in security analysis and years of practical market experience. We can help you pick the most appropriate companies to own that fit your objectives. Do-it-yourself investing is hard to do and can lead to large losses of principal. Proper investing in the stock market can be very rewarding, but you must be disciplined, able to afford risk and adapt to unforeseen events. Let us help you avoid many of the common investment mistakes that plague the do-it-yourself investor.
Gerber Kawasaki Wealth Management
2716 Ocean Park Blvd #2020
Santa Monica, CA 90405
Securities offered through LPL Financial, member FINRA/SIPC. Investment advisory services and fixed insurance offered through Gerber Kawasaki, Inc., a registered investment advisor and separate entity from LPL Financial.
This material contains forward looking statements and projections. There are no guarantees that these results will be achieved. Investing involves risk including potential loss of principal.
All investments including individual stocks involve risk including the potential loss of principal. No investment strategy such as asset allocation and diversification can guarantee a profit or protect against loss in periods of declining values.