10 investment mistakes to avoid: common errors and what drives people to make them - includes related articles on using the best investment strategies - Hot Investment Strategies - Cover Story

Black Enterprise, April, 1994 by Patricia Carey

Common errors and what drives people to make them

Are you often enticed by intriguing "no money down, get rich quick" investment offers? Or, have you been the victim of a tricky investment scam? If you answered "yes" to either question, you're not alone. These days "investors frequently are swayed by impossible promises of great income at almost no money market risk," says Eileen Sanders, an analyst for Morningstar Inc. That's why the investment pros often say in a mantra-like tone: "There is no such thing as a free lunch."

A few years ago, such promises enticed many people to invest in short-term world income funds. But many investors didn't understand that these attractive yields depended on relatively stable European currencies. When the system regulating European exchange rates fell apart in late 1992, "those funds took a pummeling and many of them are still losing assets," says Sanders.

The key to successful investing is not to avoid risk altogether but to recognize the risks you are taking. To avoid unpleasant surprises, do your homework. Nothing beats reading the prospectuses and checking the longterm performances of your investments. "People rush into purchases even when they don't understand what they're buying," says Ronald W. Roge', a fee-only financial planner and president of R.W. Roge' & Co. in Centereach, N.Y. "People do more research when they buy a refrigerator or a VCR than when they invest thousands in stock."

The sad fact is that individual investors make the same errors over and over. But don't be dismayed. Even as a novice investor you can improve your odds dramatically just by avoiding the following common mistakes.

1 Chasing numbers. Don't be so dazzled by a stock's statistical data that you don't properly analyze the numbers. If you buy a stock with a low price-earning ratio, make sure you understand what forces have pushed it down. In this bull market, there are few if any unrecognized bargains. "It could be a good deal, but it's probably not," Roge' says. Check it out before you buy it.

Similarly, if a stock boasts a lofty dividend, there's a reason. "Higher yields indicate that Wall Street feels the stock is high risk, particularly in being able to sustain yield," says Charles Carlson, editor of Dow Theory Forecasts.

2 Joining the new issue frenzy. The most promising new issues are reserved for large, preferred customers such as mutual funds or other large institutional investors. If you're offered a brand new stock for your portfolio, be wary. The brutal truth, says Carlson, is that "if a broker calls you, pitching a new issue, it's pretty safe to say it's merchandise that has been picked over already."

3 Coming late to the party. Generally you should avoid buying a stock that's already had a big run-up in value, unless you have a solid reason for expecting it to keep rising. Particularly vulnerable are stocks that have received a great deal of recent media exposure. Prices of highly publicized stocks may have reached their peak and be poised for a correction. Roge' advises waiting at least a month after such exposure before making any buys. "It's difficult, but you have to rein yourself in," he says.

4 Keeping a portfolio of individual stocks when you lack the time and expertise to monitor them. If you own just a handful of individual stocks, you're taking on two kinds of risk. One is the overall market risk (systemic risk) and the other is the risk associated with a particular stock and the underlying company (unsystemic risk).

Regardless of the dollar amount in your portfolio, making good stock picks requires keeping track of individual companies, their industries and overall economic trends. Before investing, ask yourself whether you have the time and expertise to do that on your own. If not, check out alternatives. An investment club allows a group of individuals to share their research. Or, you can invest based on the recommendations of a trusted financial adviser. (But make sure you've checked out his or her track record, references and possible conflicts of interest!) The easiest way is to follow the lead of most small investors: Confine your equity ownership to mutual funds, leaving the headache of individual stock picking to their managers.

But don't get lazy. All investors should devote some time to researching and monitoring their funds. Avoid surprises by reading your funds' prospectuses and other documentation. For example, many high-yield junk bond funds boosted returns in 1993 by investing in debt from developing countries like Argentina and Mexico. An investor who tracks only a fund's returns wouldn't necessarily know about the change in the portfolio's holdings or the increased risk it entails.

Beware of funds where top management has changed recently. A new manager may signal a change in investment philosophy. If the departing manager was responsible for the fund's stellar performance in the past, the trend won't necessarily continue.

Many investors fall into the trap of judging a fund by its name, rather than by what it actually owns, says Sanders. While the Kidder Peabody Equity Income Fund may sound like a conservative equity income fund, it's really a growth fund that lost money in 1992 and barely gained 2% in 1993. Sanders' advice: "Look at the performance. Look at the actual portfolio."