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6 Common Investing Mistakes to Avoid
02/13/2013 10:30 am EST
You’ve learned from your own investing errors. Now, let’s see what the mistakes of others can teach you, writes Rob Carrick, reporter and columnist for The Globe and Mail.
Our laboratory is The Globe and Mail’s online video series Portfolio Checkup, where I team up with an investment advisor to offer feedback on portfolios submitted by Globe readers.
If you’re selected for Portfolio Checkup, we look at your investments and assess how well they match up with your needs as you describe them to us. Overall, the portfolios we’ve seen aren’t bad at all. But there are a few recurring errors worth highlighting:
1. Flaky Stock Picks
This happens often in preparing for Portfolio Checkup: In the midst of a basically good mix of blue-chip stocks, mutual funds, or exchange traded funds, I’ll find a speculative stock or three. Often, it’s a junior gold or energy stock. Research In Motion (RIMM) crops up, too.
The bright side of tossing a stock pick or two into an otherwise well-built portfolio is that the potential for serious damage is limited. But it’s evident that many picks are based on just guesswork. They’re often money losers with no dividend to take the edge off a declining share price.
We’ve seen just one portfolio that was built in large part with speculative stocks. The person who owned it absorbed our feedback, dumped the portfolio, and is now investing in a good low-cost family of mutual funds.
2. Holding on to Losers
A portfolio I looked at recently had some Nortel (NRTLQ)shares with a book value of $4,447 and market value of 20 cents. Another portfolio had some E*Trade Financial (ETFC) shares with a book value close to $6,000 and a market value of a little less than $850.
We get asked by Portfolio Checkup candidates whether stocks like these should be sold. The answer: Unquestionably and unambiguously yes. Flushing away your bad stock picks will make you feel great and help you move forward to more productive investments.
Every investor blows it now and again. What separates the smart ones from the others is how quickly they recognize the mistake, sell it to limit losses, and move on.
3. Too Little in Bonds
We’ve heard a million times about how investors missed the stock market run-up of the past year or so because they were so focused on bonds. I don’t see that in the accounts reviewed for Portfolio Checkup. In fact, many of the portfolios—perhaps even a slight majority—are too skewed to the stock market.
One submission was sent in recently by a 50-something business owner; his seven-figure portfolio was intended to act as a retirement fund. Guaranteed investment certificates, a perfectly good bond substitute, accounted for all of about 2% of the portfolio. Add cash holdings and you’re up to about 9%. The rest were equities.
Bonds have more room to fall than rise if you look ahead a year or two, but they’re still essential as a cushion if the stock markets decline. Only ignore bonds if you think this just can’t happen.
4. Fuzzy Thinking on Bonds
I get the sense in looking at portfolios that people agonize in choosing stocks for their portfolio. The bond side? I’m guessing about three minutes’ worth of research is not uncommon, and this applies both to self-directed and advised portfolios.
One Portfolio Checkup applicant’s advisor took the risky approach of basing almost all bond exposure on a single bond issued by a real estate investment trust. Another portfolio used high-yield bonds almost exclusively. They offer among the best returns in the bond market right now, but the risk profile is not much less than stocks.
Don’t neglect the diversification of your bonds. Own some government and corporate bonds (GICs are great, too) and maybe a bit of high-yield. My experience with Portfolio Checkup suggests investors who use exchange traded funds do the best job of ensuring they have bond exposure that is sensible both in quantity and quality.
5. Missteps with Cash
One young man who came to Portfolio Checkup had a cash weighting of 38%. A senior with a large portfolio and high expectations for generating retirement income was close to 50% in cash.
Use cash for money you refuse to lose, and as a temporary parking place. As a major portfolio component, it’s close to dead money.
That’s especially true for the many investors coming into Portfolio Checkup with cash just sitting in their investment accounts. A few are using high-interest savings accounts that trade like mutual funds, but not enough. These accounts pay 1.25%, and they’re offered by such firms as RBC, Dundee Bank, Manulife Financial, and Renaissance Investments.
6. Haphazard Mixing of Stocks with ETFs and Funds
Stocks or funds—pick one. When you mix them, you run the risk of getting more exposure to certain stocks than you might want or need.
Consider an investor who came to Portfolio Checkup with four separate accounts, three of which included bank common and preferred shares. Other holdings were a Canadian equity mutual fund and exchange traded fund, where bank stocks were also major holdings.
In fact, four of the ETF’s top six holdings were banks. Financial stocks make up about one-third of the S&P/TSX composite index—if anything, you want to reduce that dominance when arranging a portfolio.
I’ve also seen a few cases of investors mismatching US stocks and ETFs. They buy an S&P 500 ETF or index fund and then add stocks such as Johnson & Johnson (JNJ), Pfizer (PFE), and Procter & Gamble (PG). Each of these three companies is a Top Ten holding in the S&P 500.
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