How
to Lose Money
Wall
Street is full of “experts” that tell investors sure-fire
ways to get rich in the market. Day-trading; buy n’ hold;
trend trading; no-loads mutual funds; buy the dips; blue chip stocks
and on and on and on. There are a zillion different ways to make
money according to the experts. But few want to tell you what NOT
to do.
Here
are the Top 15 ways we’ve seen people lose money in the market.
Many of these strategies overlap and many investors employ more
than one at a time. Of course, they are not guaranteed to lose you
money, but I’m sure if most investors work at it, they can
find a way.
1
– Do nothing – The market always comes
back, doesn’t it? If the market drops, I lose some money on
paper, big deal! It isn’t a real loss until I actually sell,
right?
Indifference,
laziness, ignorance and fear all feed this strategy. The idea is
that if you bury your head deep enough in the sand, you won’t
see your losses. And if you don’t see it, it isn’t real.
Investors
can get frozen in place. They have already made one bad decision
- that was getting into the losing investments in the first place.
They really didn’t understand what they were doing and now
they are not confident enough in their own flawed decision making
to decide what to do next, so they do nothing.
Buy
n’ holders are especially vulnerable to this because they
have bought into the Wall Street mantra of “buy n’ hold,
buy n’ hold, buy n’ hold…” They are told
to think long term. They are told long term, all the bad stuff disappears
and profits are guaranteed. They are told they don’t need
to do any thinking on their own, they just need to “stick
with it” and all their dreams will come true. They are told
wrong.
Solution:
During bull markets buy n’ hold actually does work. But because
of the cyclical nature of the markets, once the bull ends, so does
this strategy of buy n’ hold.
In
general, the “Don’t do anything” crowd needs help.
They need to either seek professional help or do some homework on
their own. Unfortunately for most investors, much of Wall Street
still believes in buy n’ hold so they aren’t likely
to find help there.
They
need to seek out independent advisors and independent sources of
research. Here again there is danger because the credibility of
many of these sources could be suspect. It comes down to investors
having to use their heads. There are plenty of sources on the Internet
for investments advice. It doesn’t mean they are all right
or should be given equal weight.
Recently,
I saw an interview on CNBC with an advisor that called the top of
the market this year correctly. He had made some other market predictions
that had been somewhat accurate and when the interviewer asked how
he knew these things, he responded that Saturn had aligned with
Mars and Jupiter was in its third phase. Un–huh. Sure.
There
are wacko’s on all sides of the investing world. It is up
to the investor to sort through the fringe elements to get to sensible,
rational investment advice.
2
– Change Strategies Often – Perfect
strategy for the impatient. If your investments haven’t given
you the
returns you expect in the first month or so, switch ’em! They
were lousy ideas to start with! Right?
Solution:
Changing from one strategy to another and then another usually doesn’t
give any strategy a chance to work. The smartest money knows that
it takes time for most long-term investments to payoff. The most
important part of the strategy is the pre-implementation work. Does
the strategy make sense? Is it part of an over-all plan? Does it
take risks into account? Does it have solid empirical data behind
it? Is it flexible?
3
– Hold onto Losers – “I’m
not selling until it comes back.” or “If you don’t
sell it, it isn’t a loss.” There is nothing like taking
the profits of stocks that have worked out. Unfortunately, not all
stocks go up. Some go down. And if you only sell the stocks that
have gone up, eventually you will have a portfolio of losers.
Solution:
Set downside targets. Once a stock has breached that price, re-evaluate
the holding with a cold eye. In most cases, you are better off selling
before it goes lower. If you can’t bring yourself to sell
a loser, every time you take a profit, pick a loser to sell. You
will have softened the pain of taking a loss and sheltered some
of the profit of the gain with the offsetting loss.
4
– Act with the Crowd on News – There
is nothing more electrifying than hearing about an exciting announcement
by an $8/sh hi-tech-bio-medical-internet company on CNBC when you
get home from work. You can’t even sleep that night just thinking
about the riches you will make when you place your buy order the
next morning.
Unfortunately,
hundreds of thousands of other saps, err, make that “wise
investors” saw the same show and are dreaming the same dreams.
So the morning opens with a mountain of buy orders and the stock
jumps 4 points on the news. Wow! You’re gonna be rich! A 50%
gain already!
Of
course, it was a gap opening (You don’t know what a gap opening
is? Too bad…) and you got executed at $11 ¾. Nice.
It hits $12 ¼ by 10:00 and the rest of the day drifts lower.
It closes the day at $7 ¾. Down ¼ from the previous
day’s close.
What
happened? The smart money was in it months ago and was waiting for
this development. There is an old saying on Wall Street, “Buy
on rumor, sell on news.” Smart money sells on good news, they
usually aren’t buying.
Solution:
Don’t look for quick hits. Don’t act out of emotion.
There is no replacement for sound research. News reports from the
media are not sources of sound research. When you hear about these
stocks that spike up in a day, think how nice it is for the sellers
and go about your business. If your portfolio is built properly,
it will have its’ share of upside surprises.
5
– Buy Hot/Trendy/Theme Stocks – Everybody
wants to invest in the next great thing - get the next Microsoft.
Look at all the money that was made in Internet stocks. Look at
Google. Those guys became billionaires. (And when you invent the
world’s best search engine, you can look for your billion
too.) Themes have come and gone over the years. There were investments
in Eastern Europe, the Internet, Biotechs, Telecoms, limited partnerships,
and the list goes on and on. They have one thing in common though.
They all were hot themes that eventually fizzled out because the
fundamentals did not support the enthusiastic predictions. For every
stock that does well, many, many more become write-offs in April.
Solution:
Same as above, don’t chase hot stocks. These stocks depend
on investor emotion, not fundamental analysis to get them moving.
If you still think it is worth the risk, go look up WebVan.
6
– Ignore Fundamentals – “I don’t
need no stinkin’ fundamentals!” Why bother with all
that work? You know everything you need to know about your investments.
High debt to equity ratios don’t bother you. High PEG ratios
are fine. And who needs to know about interest coverage? That stuff
just gets in the way of making fun investments.
Solution:
Watching the fundamentals keeps investors from making dumb investments
like most of the Internet stocks, telecoms and many IPO’s.
Looking closely at the company will give early warnings of debt
problems, earnings slow-downs and increasing competition. Understanding
that stocks with PEGs over 1.00 might be a bit pricey.
What
if you don’t have the time or ability to do the research necessary?
Can you rely on your broker or money manager? Most of them are not
licensed Research Analysts. They are just repeating what their research
department is saying and the recent
conflicts of interest and research scandals on Wall Street have
shown them for what they are worth.
Investors
need to seek out independent, licensed Research Analysts. Then review
their information to see if it is more hype that substance. There
are plenty of sources for research. But no one is going to be right
all of the time. The solution is to look for consistency and flexibility.
If the vast majority of recommendations are buy rated, the investor
should question the veracity of the opinions. If there is a good
mix of buys and sells and holds, then that shows the analysts is
rating stocks without worry of outside influence either from his
own company or the companies he is covering. (It still doesn’t
mean he’s going to be right though.)
7–
Focus on Costs – Cheaper
has to be better. This is what the media hammers into investors
every day. Through newspapers, investment magazines and TV, investors
are repeatedly told they shouldn’t pay fees and if they have
to, they should pay the lowest possible fees.
The
logic is backwards. If you want the best of anything else, best
doctor, best lawyer, best car, best food, you have to pay more for
it. It is illogical to assume you will get the best money management
for the lowest fees. In fact, a recent Yahoo! screen of the top
ten performing mutual funds over the past five years show that five
of the funds had internal fees higher than average and five had
fees lower. What does it mean? Fees didn’t matter. (The same
screen was done for the worst ten for five years. Again it was split
50/50 above and below average fees.)
Yes,
all things being equal, if you are looking at two identical funds,
then the fees will make a difference. But since very few funds are
identical to another, the cost issue is not as important. Don’t
get me wrong; there are some funds with outrageous costs. But when
it comes down to as little as ½ percent between choices,
cost should not be the primary focus for decision-making.
Solution:
Always review costs and make sure you know what they are. Unless
they are unusual, they shouldn’t be a determining factor in
an investment choice. The most important factor should be the management
of the funds. They should have a firm grasp of the current environment,
with a good track record, a clear plan for the future and the ability
to be flexible.
Unfortunately
for the media, these characteristics aren’t as easy to quantify
as fees are. So they will continue to focus on what is easy, but
wrong, and smart investors will know what is really important.
8
– Read everything you can on investing –
Some people read everything they can get their hands on and treat
it like it is Gospel. They watch all of the business reports as
if the are seeing prophets on earth. What happens to many of these
investors is information overload.
Information
overload is when you read one article in the morning that says XYZ
is a great company, then you hear on the news later in the day that
XYZ was downgraded by a Wall Street firm. Who do you believe?
Investors
usually react in one of two ways. They either act on the information
and end up switching investments constantly, depending on which
way the wind is blowing that day. The other response is to discount
the information. They feel that there are equal and opposite opinions
on all sides of issues, strategies and investments. This leads them
to believe that no one is right and no matter how strong an argument
may be, it is ignored.
Solution:
As strange as it may seem, stop reading so much. Stop watching the
business news on TV. The people in the media don’t know your
situation so they are not making recommendations for you. They are
reacting to the most recent bit of information about a company or
the economy. They take that information and extrapolate it out to
its best or worst possible conclusions, usually neither of which
are right.
If
your portfolio has been constructed properly, you have taken future
possible events into account based on solid research. Very little
should surprise you. A well-managed portfolio doesn’t react
to every fragment of data that comes out.
9
– Chase Yield – If 3% is good, 5% must
be better and 8% must be great! In low interest rate environments
like we have today, investors have to search for yield. It isn’t
like the good ole days of the early eighty’s when rates were
higher and you could buy 7% utilities and 9% bank CDs. So to get
those yields, investors are dropping their inhibitions and turning
a blind eye to risk while snapping up junk bonds (around 8%) and
royalty trusts (around 10%) just for the income.
What
they don’t understand is the ramifications of higher interest
rates. As rates go up, junk bonds can suffer tremendous losses.
This is because their credit quality is suspect for a reason. There
isn’t just the potential loss from the bond price due to higher
prices. There is potential default from the issuer. This doesn’t
mean you lose some money, the investor can lose it all - income,
principle, everything. Foolishly, investors are willing to risk
everything for a few extra points of yield.
Solution:
Most investors don’t even know they are chasing yield. They
think they are being wise investors, looking for the highest possible
cash flow from their investments. They don’t understand the
risks or worse, are in denial about the risks.
If
you find yourself investing just for the higher yield, if you find
yourself complaining about the low yield on your money market, if
you start looking at esoteric investments because of the higher
interest or dividend, you are chasing yield.
Unfortunately,
in a low interest rate environment, investors that actually do need
higher yields are stuck with few alternatives. (I’m talking
about the people that actually live off the income, not the impatient
investors with a diverse portfolio that are trying to squeeze an
extra half point of yield out of their investments, as if that will
make a difference.)
People
that need higher cash flows to live on have to accept the fact that
safe interest rates give returns below their needs. So they either
adjust their life style to the low rate environment, or accept higher
levels of risk. If they accept higher levels of risk, then they
can open up the potential for income to more than just junk bonds
or high yield stocks.
A
well-crafted portfolio can put together offsetting components. Since
the Fed has started raising interest rates, it isn’t logical
to put all or most of one’s assets into the bond market buzz
saw. There are other investments that perform during rising interest
rates and inflation. By adding these to a portfolio, the investor
can offset some of the downside of the required bonds.
The
investor has to understand that to get the higher cash flow they
need, they will have to depend on both income (interest and dividends)
and capital gains. It is the second part that scares most people.
Contrary
to most of what you have heard, bonds are not always less risky
than other investments. During a rising rate environment, bond’s
risks rise. So other investments like some commodities and some
equities actually have less risk under certain circumstances. This
is because higher inflation is beneficial to them. But they produce
little to no income, so in order to generate cash flow, they have
to be sold off at various points.
Putting
together a portfolio like this and then managing it properly takes
experience and discipline.
10
– Let taxes determine when you to sell. –
Nobody likes to pay taxes. Worse is when you have a nice big gain
and then you consider the taxes! Ouch! But you have a way to reduce
the taxes - just wait until such and such a date, usually a year
after you bought the security, and the capital gains tax is reduced.
There, problem solved. Of course now you just have to hope and pray
that the investment stays up until then.
And
that is the problem. Once a decision to sell a security has been
made, unless the one-year anniversary is within a few days, the
investment should be sold, regardless of tax consequences.
Here’s
what happens: You buy XYZ corp. for $30/sh. It goes to $42/sh after
9 months. It has hit your target price. It has also hit many analysts’
targets and the technical chart is indicating a sell. If you sell
now, the gain will be at your own income tax rate of 28%, not the
lower capital gains tax rate of 15%. But all indications are that
the stock could fall as much as 25%. If you sell now, the tax will
be 28% of the gain, a tax of $3.36/sh. The capital gains tax rate
would be only $1.80/sh. A difference of $1.56/sh. But the risk is
a 25% decline. That translates to $10.50/sh. Amazingly, many investors
are willing to accept the risk than to pay the small but additional
taxes.
And
what happens? Of course, the stock declines and the investor is
holding onto a stock they wished they had sold months before. So
now the magical 1-year anniversary arrives and they sell at the
lower tax rate. The tax on a gain of $1.50 (remember, the stock
declined 25%, wiping out $10.50 of the gain.) is only 23 cents/sh.
Add that to the $10.50 loss from the original sell signal. Waiting
cost them a total of $10.73/sh. But good for them! They paid lower
taxes…
Solution:
Yes, taxes are important, but they shouldn’t be the primary
driver in your investment decisions. They should be considered.
If you are thinking about taking a gain and you notice the one year
anniversary is in a couple of days, it may be prudent to wait. But
delaying a sale for weeks or months to save a little on taxes could
be an unsuccessful strategy.
If
your portfolio is being done correctly, taxes would be considered
a cost of doing business. Sales are made because of fundamental
reasons and the timing is usually because of specific technical
indicators. These factors don’t take your personal tax situation
into account. If a stock is poised to reverse, it is going to drop,
regardless.
This
doesn’t apply to investors in the top tax brackets in need
of tax-free income. They have a single choice, municipal bonds.
There are strategies for managing a portfolio of muni’s but
that is for another time.
We
won’t even discuss tax schemes except to say if it looks to
good to be true…
11
- Don’t know what you own – There’s
the green statement, the blue one and the red one. That is about
as far as some investors go in getting to know what their investments
are. Many times investors buy stocks without knowing what the company
even does. We’ve seen investors with a large variety of mutual
funds that had virtually the same holdings.
Solution:
If you don’t know what they are, why invest in them? Investing
blind is nothing more than gambling. If you don’t know what
you own and why you own it, you need to either do the research to
get to know your investments or hire a professional money manager.
12
- Ignore cycles – Markets are cyclical. Stocks
are cyclical. Economies are cyclical. But not your investment portfolio!
Somehow, you’ve been able to defy the laws of economic cycles
and have put together a portfolio of investments that is not influenced
by market and economic cycles.
Solution:
For the rest of us, cycles are important and understanding the cycles
is even more important. Just as day is followed by night; bulls
are followed by bears; inflation is followed by deflation; a paper
asset cycle is followed by a hard asset cycle.
Knowing
what the tops and bottoms of these cycles look like will determine
what the appropriate asset allocation for a portfolio should be.
It isn’t prudent own bonds when interest rates are going up.
It does make sense to own hard assets when inflation is picking
up. Owning stocks in a bear market isn’t wise, while owning
foreign bonds when the US Dollar is dropping is sensible.
13
- Don’t have a bear market strategy –
They won’t let a bear market happen; a bear market won’t
happen again; I own good stuff, I won’t be hurt if it does
happen. None of these are bear market strategies. They are perfectly
fine if your intention is to lose money. Not so good if you want
to protect yourself.
Solution:
In a bear market, what worked going up, gets killed going back down.
But that doesn’t mean that nothing works. Wall Street has
done a good job of teaching investors to think in binary terms –
to think as if there are only two investment choices, stocks or
cash.
But
that is far from the case. Today we have funds designed specifically
to take advantage of bear markets. We have commodities and hard
asset funds. We have foreign equity and bond funds.
A
bear market in stocks just means stocks should be avoided, but there
are all sorts of other investments available.
14
– Try to Buy at the Bottom, Wait to Sell at the Top
– You are nobody’s fool. You don’t want to pay
a penny more than you have to for your stocks, no sir-ee! And when
you sell, you wait until the stock is at its peak before selling,
anything less and you have failed. People that buy before the stock
hits bottom are chumps and those that sell before the top are suckers.
You aren’t going to be fooled like those losers!
The
problem is when does a stop bottom out? How do you know when you
are buying it is the bottom? And then when you sell, how do you
know it is the top? Does a bell ring? Does your stomach rumble?
Do the voices in your head tell you?
The
reality is that investors that try to buy the lows and sell the
highs never do it. Accept that stocks usually go lower after you
buy them and higher after you sell them.
There
is an old saying on Wall Street – Bulls make money, bears
make money, pigs get slaughtered. Since almost no one sells at the
high, this type of person usually misses the high and then watches
his or her stock fall back. When will they sell? It has been our
experience that they will wait for the stock to get back to the
old high. This is usually a losing strategy.
Solution:
Have a disciplined buy and sell strategy. Know why you are buying
a stock and what circumstances will cause you to sell the stock.
Have price targets both above and below your purchase price. Think
about anticipated events that will trigger a sell signal.
Accept
that you will not be able to buy the low and sell the high. After
selling a stock, don’t look back. If it goes higher that is
fine. You are not a pig. You don’t want all of the profit.
Older timers say wise stock traders leave some profit on the table
for others.
Bonus
- You Don’t Need Professional Advice
– Brokers are only out for themselves. You know they
are just in it for the money. They don’t know much more than
you do. That is what all of the ads from the discounters say isn’t
it?
Surprisingly,
I partly agree with these statements. Many advisors don’t
know what they are doing because they neither have the ability or
the inclination to do their own research. They work for firms that
do that for them and there is no reason for them to question the
company’s research. Success is not measured in client portfolio
performance, it is measured in assets under management and commissions
and fees generated.
But
this doesn’t mean all advisors are this way. Many work hard
at putting the client first and doing the right thing.
But
here’s the thing, and there is no getting around it. If you’ve
been at your job for more than a few years, do you think someone
from the outside could take over for you and do the job as well?
How about if you’ve been doing the same job for 10 or more
years? Do you think an outsider could do as well as you, given your
years of experience and wisdom generated by those years? Of course
not.
Managing
money is a difficult, hard, time-consuming job. Like any other profession,
whether it is a doctor or lawyer or accountant, there is no substitute
for experience.
Solution:
Unless you are blessed with a full understanding of investing, financial
planning and money management, you should seek out some type of
professional advice.
To
get a good referral, talk to friends, ask around, or search the
web. Look for someone with experience, independence and most of
all, someone you get along with and trust. Of course find out their
track record, but most of all, find out what their current strategy
is and how it will change. (Buy n’ hold is not a strategy.)
An
independent firm with a licensed Research Analyst has the ability
to publish research reports. They have a leg up on those that are
not licensed. Investors know that they are doing their own research
and don’t have an ax to grind.
No
investor does all of the above, but many have done several at the
same time. Investing is not easy. The research needed to understand
the markets is never ending. There is no substitute for experience.
Get-rich-quick
schemes do not work. Investing is a process. It takes time. It takes
patience and discipline. If your investment goal is XYZ Dollars,
don’t expect to get there immediately or in a straight line.
Investment
portfolios should be put together in such a way that a decline in
any single issue won’t upset the performance. They should
be set up in such a way that there are offsetting pieces of the
pie that take up the slack when another part falters.
But
most of all, investing is about using your head, common sense and
logic.
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