Published August 09, 2013
Wall Street’s bull run this year has sent stocks soaring some 19%, extending the markets’ lurch from bear-market lows hit in 2009 to 151% and enticing many first-time investors to take the leap into the equities world.
Wall Street might be enjoying record highs, but market experts say current market conditions have changed the investing game. “This is obviously not a market operating on fundamentals,” says Lance Roberts, CEO of Street Talk Advisors. “There’s only three days in August that don’t involve the Federal Reserve not buying debt and that pushes up liquidity. All the normal rules get thrown out the window.
While no one has a crystal ball, Wall Street started to pull back this week, the Dow and S&P 500 posted their worst two-day losses on Tuesday since late June. “After the last 18 months, where we have seen the markets go up by 18%, it would be greedy to expect to make a lot more over the next six months,” says Scott Armiger, certified financial advisor and vice president of Christiana Trusts.
The cardinal rule to investing sounds simple: Buy low, sell high. But that’s easier said than done.
“You should always stick to the basics, buying low and selling high will retain a margin of safety,” says Roberts. “If you don’t do that, your return on investment is going to be very low or negative at the end of the day, there’s very little margin of safety today.”
So before first-timers take their leap into the markets, here’s what experts say are the most common investing mistakes and how to avoid them:
Unrealistic expectations. Recent headlines are screaming about Wall Street’s record rally, but consumers tend to have short-term memories and forget that pullbacks are part of a normal cycle, says certified public accountant Harold Wong.
“Don’t expect to make more than 2% in bonds and 4% in the stock market right now,” he advises, referencing a forecast from Pimco’s chief investment officer. “We don’t have the necessary economic growth; only a few companies will succeed just because they are better innovators.”
Short-term thinking. According to Kristin Fafard, president and chief investment officer of Federal Street Advisors, you should plan to keep any investment in the market for 15 years. “We found that you have a higher probability of meeting the equity return if you do it from a 15-year perspective. You have an even greater chance with 20 years.”
Armiger points out that over the last 85 years, the stock market has brought an average 10% return to investors. “If you take the long-term approach you will be fine, don’t try and time it, even if you include the down years where you might lose 13%, that won’t bother you.”
Before creating an investing budget, Fafard recommends forecasting any liquidity needs to make sure your money isn’t tied up when you need it. “If you know you are going to need cash for a down payment or anything else, don’t put that into the market, put that in something like a two-year duration bond or CD and match the end date with your expected liability.”
Picking the wrong advisor. Lots of experts agree that you don’t necessarily need an advisor. But if you do seek professional help, it’s important to ask for referrals and look beyond appearance.
“Wall Street and big banks force their employees to wear fancy suits and put them in big shiny offices, but appearance is not reality. Bernie Madoff was a sharp dresser,” says Wong.
He says investors often misprioritize what traits they want from an advisor, ranking relationship and service higher than knowledge, honesty and good service. “Don’t be fooled by big offices and suit labels, know the current realistic rate of return and ask them to project their performance expectations. If the two numbers aren’t close, that’s a major red flag.”
Failure to diversify. Asset allocation is the key to long-term success to conserve your principal.
“It’s good to be in both individual stocks and mutual funds,” says Armiger. “Mutual funds and ETFs can be a good starting point for new investors because they provide instant diversification.”
Roberts also suggests not overlooking the bond market. “So little attention is given to this asset class because it’s not as sexy, but not losing money can be more important than making money in some cases.”
Stalking your investments. It can be hard to ignore the blaring headlines and experts on TV, but trading on every news report and professional tip can be detrimental to your strategy.
“People watch their stocks every day and torture themselves and feel the need to make changes, but we always try to remind our clients, if you wait long enough you will get a return,” says Armiger.
Farfard adds that you must leave your emotions at the door. “Ask yourself if what you are hearing on the news is something that will persist 15 years down the road. When you diversify your portfolio, you spread your bets.”
Not determining your risk tolerance. Investing in the stock market is always a gamble, but it’s important to identify your risk level.
“It’s false that if you take more risk, you make more money. If you bet on a pair of twos in poker you are going to lose,” says Roberts.
Forgetting your role. Armiger recommends investing newbies treat investing like a business and to invest in businesses that you use and know.
“Don’t mistake an investment for a trade,” he says. “One of the worst things you can do it make a little bit of money in a short period of time and try and sell it right then, and three to five years later, they see it’s doubled or tripled.”
Roberts adds that the success secret behind every great investor, is that they stick to what they know. “At the end of the day, we are all betting on the future and we need to have the realization that our goal is to sell what we have to the next sucker for a higher price,” he says.
Overpaying. Before buying any stocks, do your homework and determine its worth.
“Look at the price of the investment versus what they are earning. If the investment is 10-15 times what it is earning and the company doesn’t have a lot of debt, you will do OK,” says Armiger. “But people tend to gravitate to what is hot right now, and that can be very expensive and people tend to over pay.”
Case in point: After a much-hyped public offering, Facebook (FB) shares debuted at $38 a share, it took more than a year for the social network’s stock to get back to that level.
Waiting too long. When it comes to investing, time is your friend.
According to Roberts, the average individual investor is facing a tight deadline. “The mahority of people looking to get into the investment world has only 10-12 years before retirement, that’s not a lot of room for mistakes or riding out any tough times.”
Experts recommend to take the investment leap during your first year at work, whether it’s on your own or through a 401(k) plan.
“The sooner the better, the better says,” Armiger.