10 Big Investing Mistakes

By Selena Maranjian
The Motley Fool
November 5, 2004

The nice folks at Investor's Business Daily (a newspaper for investors that you can try for free) recently assembled a list of big investing mistakes. I found the list interesting, not only agreeing with some of their items but also taking issue with a bunch of them. Here's a brief recap of their 10, along with a few comments.

1. Avoiding stocks with high P/E ratios. Stocks with the best potential often sell at a premium.

I agree with this. Stocks with high P/Es are often tied to companies growing quickly or to firms with stellar reputations. (For some recommended fast-growing companies, look into our new Motley Fool Rule Breakers newsletter, which you can also try for free.) But keep in mind that sometimes a high P/E is attached to the stock of a company that isn't a compelling investment -- it's just gotten way ahead of itself in price and isn't likely to reward investors any time soon. A little research and thinking can help you sort out which camp a high-P/E candidate belongs to.

2. Not cutting losses short. Small losses can easily be overcome. It's the big losses that can do severe damage.

While this is indeed often a mistake, it's also often a mistake to sell a holding just because it's fallen a bit, or even a lot. Stocks rarely go up (or down) in a straight line. You have to expect some volatility. If you're concerned about a holding that seems to be sinking, learn more about the situation before selling. Sometimes stocks fall for good reasons -- such as when there are serious, long-term problems. Other times, a fixable, short-term problem can temporarily sideline a stock, and it may be worth hanging on. Think of Johnson & Johnson (NYSE: JNJ), for example, and its Tylenol-tampering scandal of the 1980s. Selling after the stock sank wasn't best, since the company regained its footing soon enough.

3. Buying stocks in a down market. Three out of four stocks will follow the market's trend.

Hmm... well, when the market is down is often a good time to buy, in my opinion. Sure, many stocks you buy may fall some more before gaining ground, but these are the times when you can more easily spot bargains and when the stocks you've always wanted to own may finally be selling for reasonable prices.

4. Averaging down. Throwing good money after bad is a sure way to stale returns.

This is a great example of how investing advice can often be contradictory. Yes, many bad investments take a while sinking to their nadir, and it would be a terrible mistake to keep buying them as they fall. Don't try to catch a falling knife, as they say. But on the other hand, as I mentioned above, many times good stocks will drop temporarily, and those are good times to load up on extra shares (if you're truly confident that the problems are fixable and temporary). I face such a situation now with Netflix (Nasdaq: NFLX). I bought some shares a few weeks ago, and several days later the stock dropped 40%. Ouch! So now I need to reassess the situation and decide whether to sell, hang on, or perhaps buy more shares. (For now, I'm likely to just hang on.)

5. Buying stocks because they pay a dividend. Why are so many dividend-paying stocks such laggard price performers?

Well, it may be true that some dividend-payers don't offer much satisfaction in the price-appreciation department. But many others do. In the world of dividends, you sometimes can have your cake and eat it, too. Our Motley Fool Income Investor newsletter, for example, has recommended more than 25 investments in a little more than a year, and only a small handful (four at last count) feature negative total returns. RPM International (NYSE: RPM) gained nearly 30% (total return) in its first year since being recommended, while Southern Company gained about 8%. It can be very worthwhile to consider dividend-paying investments -- learn why in this Mathew Emmert article, "How to Achieve 20% Yields."

6. Buying on rumors, tips, opinions. There was a lot of bad advice given when the bear market began in March 2000.

I can't argue with this. It's very true.

7. Avoiding stocks at new highs. When a stock hits a 52-week high, there's usually a bullish story behind the move.

Well, this may be true, but all great stock performers have to hit new highs eventually. I wouldn't necessarily avoid all such stocks, but again, I'd want to take a close look to see how much substance vs. story there is behind the recent moves. Ideally, try to determine whether the stock is still a good value at the current, "high" price. Philip Durell can help you find good values -- learn more in "The Hunt for Value."

8. Staying married to a stock. Microsoft (Nasdaq: MSFT), EMC Corp. (NYSE: EMC), and Cisco(Nasdaq: CSCO) led the '90s bull market. but they're not leaders anymore.

This is very true. You need to keep up with your holdings and try to view them dispassionately. Marriages don't always work, in both love and investing.

9. Over diversifying the portfolio. Owning too many stocks can dilute your returns.

I agree with this one very much. The more companies you invest in, the less power each has to boost your portfolio. Also, the more firms you own, the more firms you have to keep up with -- which takes a lot of time. If you own stock in 30-40 companies and fail to keep up with each of them, you may end up with some nasty surprises as some companies lose their edge and their stocks fall. "Focus investing" is the answer, as long as you have a good handle on the few stocks you choose to own. Learn more in Whitney Tilson's "Focus Investing." Tom Gardner discussed why companies themselves should focus in "Focus! Focus! Focus!"

10. Buying low-priced stocks. Cheap stocks lack a key trait of past market winners -- institutional sponsorship.

Here I agree because the absolute price of a stock isn't very important. A $500 stock may be a great bargain, while a $2 stock may be grossly overvalued. That said, some low-priced stocks can turn out to be very good performers. You just need to assess much more than the share price.

More mistakes
Reading and thinking about investing mistakes are great ways to improve your investing. Learn where others went wrong, and you can try to avoid their blunders. Study where you yourself went wrong and why, and you may be able to tweak and improve your own investing approach.

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