Stock Basics: Avoid Common Errors
One requirement for successful investing is keeping mistakes to a minimum. These eight mistakes recur with unnecessary frequency.
Do you own stocks or stock funds? If the answer is yes, this tutorial can help you develop a portfolio that makes sense for you. If the answer is no, this planning center has the information and advice you need to confidently place your first buy order.
One requirement for successful investing is keeping mistakes to a minimum. What are the most common ways investors go wrong? Kiplinger's Personal Finance magazine has examined this question over the years and counts eight mistakes that recur with unnecessary frequency. Forewarned is forearmed.
1. Not having an investment plan.
Without a long-range objective, you fail to decide in advance what type of company you want to own stocks in — long-term-growth companies, cyclical firms or speculative ones.
You don't decide whether you want current income or capital gains. You shoot from the hip. Or you abandon your plan when the market is bursting with optimism or sulking with pessimism. (See Establish Your Game Plan.)
2. Not taking the time to be informed.
Failing to get information about a company before investing in it is the most common form of this mistake. Some investors buy stock in a company without knowing what the company makes and what the future might be for that kind of product.
3. Not checking on the quality of your advice.
Many investors don't check on brokers or advisers before doing business. They don't investigate their educational or professional background. They don't ask to see sample accounts. (See Recruit the Right Broker.)
4. Investing money that should be set aside for another use.
People tie up money that should be available for emergencies or for the purchase of a new car or another predictable expense. If you invest what should be emergency funds in stocks, you may be forced to sell at a loss.
5. Being optimistic at the top and pessimistic at the bottom.
Optimism and bullishness are infectious, as are pessimism and bearishness. Thus, even when the market is high by such standards as the ratio of prices to earnings, people go right on buying.
They do it because everyone seems to be buying, or they assume that what has been happening will continue to happen, or they mistakenly think there is an exact correlation between the stock market and business conditions.
Conversely, people grow increasingly pessimistic as the market drops and tend to reach the bottom of the pit when stocks are cheapest. This may be when you should be buying, or at least holding on to what you have.
6. Buying on the basis of tips and rumors.
There's hardly any chance that the average investor will get advance or inside information about any company whose stock is publicly held. And even if you do, it probably won't do you much good. Professional speculators are watching the market news all day long, ready to buy or sell on a minute's notice.
There are also specialists in each stock listed on the exchanges. At any rumor about a company or unusual change in the volume of trading, the specialist calls the company's management and gets the facts. So no matter how hot a tip you hear, plenty of people knew it before you did.
7. Becoming sentimental about a stock.
Some investors grow so attached to their stocks they hold on long after the potential for profit has passed. A similar mistake is to fail to sell a stock because you hate to admit you were wrong to buy it.
QUIZ: Test Your Investing IQ
8. Buying low-priced stocks on the theory that they will show the largest percentage gains.
A low-priced stock may be a bargain, but not necessarily because it is low-priced. The price of a stock is what the marketplace believes the company to be worth divided by the number of shares outstanding. A stock that sells for peanuts does so because that's what the market thinks it's worth. Period.