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...