4 mistakes to avoid for a more profitable 2011

4 mistakes to avoid for a more profitable 2011

Pat McKeough

Which way will markets go in 2011?

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In the past few weeks, I’ve written about what you need to do to succeed as an investor. But it also pays to learn what not to do. You need to avoid making all-too-human errors that seem logical and conservative when you make them, but are sure to cost you money.

Here are four mistakes to avoid if you want to make 2011 more profitable.

1. Don’t sell your top-quality stocks just because they’ve gone up.

Selling your best stocks too soon is a particularly big risk for 2011. When the market recovers from a black hole like the one it fell into in 2008 and 2009, somebody always says it has gone up “too far and too fast.” Applying this pseudo-conservative advice gives you an excuse to take profits, which appeals to us all. But it hurts your results in the long run.

In the course of an investing career, some of your stocks will go up way more than you’d ever guess, some do about as well as you’d expect, and some stagnate or fall. The top performers contribute an over-sized part of your lifetime profit.

You need a few “five baggers” (stocks that go up, say, 500 per cent) to make up for the inevitable losses of 20 per cent to 40 per cent or more that strike every portfolio. If you’re too quick to sell stocks that seem to have gone up “too far and too fast,” you’ll never have any five-baggers.

2. Don’t be afraid to sell speculative stocks.

My advice in point one above applies mainly to well-established companies. In contrast, you should be ready to take at least partial profits in any low-quality stocks you own that go up substantially.

Of course, it takes judgment to spot low-quality stocks. But some of their chief earmarks are a lack

of earnings history, a dependence on projects that are still under development, and investor relations material (press releases, websites, emails and so on) that seems promotional rather than informative.

You may want to apply the “sell-half rule”: sell half of any speculative stock you own that doubles, so you get back what you initially invested.

3. Don’t settle for profitless security.

The marketing directors at financial institutions are just like their counterparts at soap companies. They don’t want to create products that are bad for you or will hurt you. They just want to create products that you’ll buy.

Today, investors are huddled on the “fear” end of the fear-greed spectrum. One way to appeal to them is to come up with innovative financial offerings that provide a no-loss guarantee.

The problem is that guarantees cost money, and buyers pay for them. That’s one reason why “guaranteed” investment innovations generate far less profit than stocks, plain-vanilla mutual funds, or other forms of ‘un-guaranteed’ investment. For that matter, the guarantee may be far flimsier and loophole-riddled than you’d guess from reading the sales brochure.

You only learn about these limitations by reading and understanding the prospectus or offering memo. In general, the closer you look at the fine print, the less likely you are to buy.

4. Don’t close your mind to new information.

When shopping for a new car, you may at first feel equally drawn to a Ford and a Toyota. If you buy the Ford, an all-too-human mental process takes hold. You begin to ignore faults that occur in Fords, and disregard anything good about Toyotas.

This is your mind’s way of making peace with your decision. In today’s world, it’s a good thing. Most of today’s cars can do what most consumers expect. Besides, replacing a new car soon after you buy is expensive and wasteful, and we all have better things to worry about.

Unfortunately, the same process takes hold when you buy a stock, or begin dealing with a new broker. But investments and brokers vary more widely in quality than do cars.

You aren’t (or shouldn’t feel) stuck with those that turn out to be bad choices. That’s why you should keep an open mind about your investments. That’s good advice this year and every year.

Pat McKeough is a portfolio manager and publisher of investment newsletters.