Beware of the deadly sins of investing
You’ve probably heard of the seven deadly sins. Well, the investing world has its own set of deadly sins.
To be a better investor, you’d do well to recognize the following missteps and learn how to overcome them.
Following the herd
Following the herd works when you shop for a product. A car or washing machine that’s performed well in the past is likely to excel in the future.
The opposite is often true in finance. What’s hot today is likely to be cold tomorrow, and vice versa.
“If you expect investment performance to repeat, you are likely to be disappointed,” said Fran Kinniry, a strategist at the Vanguard funds. In fact, the herd tends to gather the most strength right before the investment it is chasing goes off a cliff.
Ill-timed moves in and out of funds, sectors and markets go a long way toward explaining why the performance of fund investors is decidedly poorer than the reported results of their funds.
Redemption: Follow rules, not herds, suggested Bill Allen, vice-president of the private client advisory group at Charles Schwab. These rules can be as simple as refusing to buy or sell in response to news reports, or making sure you invest the same amount every month.
Resisting the urge to follow the crowd can prevent you from committing the sin of buying high and selling low.
Giving in to fear
Avoiding losses is Warren Buffett’s first rule of investing. Since the 2008-’09 stock market meltdown, however, many investors have taken the Oracle’s advice to an extreme and abandoned stocks for the seeming safety of such things as bonds, bank accounts and money market funds.
But what the typical investor sees as risk is merely volatility — normal day-to-day swings in the market. Although volatility can be frightening, the real danger lies in being too afraid of risk: You lose buying power — permanently.
For example, suppose you invest in a Treasury security or bank account that pays 0.5 percent annually. With inflation at 2 percent today, you’ll actually lose 1.5 percent per year in buying power. The loss will be greater if inflation reverts to its long-term average of 3 percent per year.
Redemption: Put the stock market’s day-to-day volatility out of your mind and focus on the long term. Since 1926, U.S. stocks, as measured by Standard & Poor’s 500-stock index, have returned nearly 10 percent a year.
Even if you had invested in the market at the March 2000 peak and held on through two horrific bear markets, you would have earned 3.4 percent annualized — not great, but not disastrous, either.
Kathy Kristof is a contributing editor to Kiplinger’s Personal Finance magazine.
© 2013 Kiplinger’s Personal Finance