Evaluating Six Investing Mistakes to Avoid

I read this article today, and he invited comments.  Here are my comments (his words are in italic):

While no investment approach is successful all of the time, here are six common investing mistakes to avoid:

Inability to take a loss and move on.

This is a good point, subject to what I will mention later.  If you learn new data about a company, such that you conclude it is worth far less than your original estimates, yes, it is likely you should sell.

But often when investors sell after a disappointment, they sell too cheaply.  Bounces often come after disappointments.  The key question is to estimate the new value, and calculate a new implied return, and compare that against the implied returns of alternative stocks.  Are you holding the stocks with the best set of likely returns?

Not selling winners.

The stock may have been a winner, but that doesn’t mean it can’t win more.  Don’t look through the rear-view mirror.  Look through the windshield.  What is your estimate of value NOW?  It may be a lot more valuable than when you first purchased it.  If uncertain, sell a little bit of it – it helps psychologically to do that, because taking a gain will make you more comfortable about the remainder of the position.

But if the stock is one of your leading ideas, even after a run-up, why sell any of it?  Again, rank the idea against the alternatives that you might reinvest in, and choose the idea that gives you the best likely returns, adjusted for risk.

In my opinion, too many people trim winners that have more to run.  Be bloodless, and evaluate the future prospects of the company versus those of alternatives.

Not setting price targets.

Fixed price targets are foolish.  Price targets should be dynamic, and shift with the estimated value of the firm.  Further, evaluate companies against alternative investments.  Only sell the stock of a company when you have a company significantly better in terms of implied returns to replace it with.

Trying to time the market.

I agree that it is difficult to time the market.  That doesn’t mean that it is not worth trying to do it on an intermediate-term basis.  Follow the credit cycle in the corporate bond market, and you will have a good idea of where stocks are likely to go.  When corporate lending falls apart, so do stocks.  Also, momentum tends to persist, so be more aggressive when stocks are above their 200-day moving average, and less aggressive when below the average.

Worrying too much about taxes.

In general, I agree.  Taxes are a secondary concern, particularly for those who use stocks for charitable giving.  Donating appreciated stock is a home-run strategy for those with long-term capital gains.

Not paying attention to your investments.

This is true.  If you can’t evaluate you own investments, you should get a professional to do so.  By professional, I mean someone trained to understand how investing works, because few truly get how it works.  They should at least hold a CFA Charter, and hopefully show some competence beyond that to show that they have transcended the training of one with a CFA Charter.

My main points to you are these:

  1. Don’t look through the rearview mirror.  Look through the windshield, and pick the stocks that offer the best returns now.
  2. Only buy a new stock when its implied returns are better than most stocks in your portfolio.
  3. Only sell a stock in order to fund a new stock with better implied returns.
  4. Good investing is a lot of work.  If you can’t do it, get a professional to do it for you.
  5. Consider taxes to the degree that it makes sense, and donate appreciated stock when you can.

The author’s six investing errors have a modest amount of merit, but the intelligent investor is dynamic, and adjusts to changing market conditions.  Your assets should be managed by those who are similarly dynamic, if you can’t do it yourself.

I read this article today, and he invited comments. Here are my comments (his words are in italic):

While no investment approach is successful all of the time, here are six common investing mistakes to avoid:

Inability to take a loss and move on.

This is a good point, subject to what I will mention later. If you learn new data about a company, such that you conclude it is worth far less than your original estimates, yes, it is likely you should sell.

But often when investors sell after a disappointment, they sell too cheaply. Bounces often come after disappointments. The key question is to estimate the new value, and calculate a new implied return, and compare that against the implied returns of alternative stocks. Are you holding the stocks with the best set of likely returns?

Not selling winners.

The stock may have been a winner, but that doesn’t mean it can’t win more. Don’t look through the rear-view mirror. Look through the windshield. What is your estimate of value NOW? It may be a lot more valuable than when you first purchased it. If uncertain, sell a little bit of it – it helps psychologically to do that, because taking a gain will make you more comfortable about the remainder of the position.

But if the stock is one of your leading ideas, even after a run-up, why sell any of it? Again, rank the idea against the alternatives that you might reinvest in, and choose the idea that gives you the best likely returns, adjusted for risk.

In my opinion, too many people trim winners that have more to run. Be bloodless, and evaluate the future prospects of the company versus those of alternatives.

Not setting price targets.

Fixed price targets are foolish. Price targets should be dynamic, and shift with the estimated value of the firm. Further, evaluate companies against alternative investments. Only sell the stock of a company when you have a company significantly better in terms of implied returns to replace it with.

Trying to time the market.

I agree that it is difficult to time the market. That doesn’t mean that it is not worth trying to do it on an intermediate-term basis. Follow the credit cycle in the corporate bond market, and you will have a good idea of where stocks are likely to go. When corporate lending falls apart, so do stocks. Also, momentum tends to persist, so be more aggressive when stocks are above their 200-day moving average, and less aggressive when below the average.

Worrying too much about taxes.

In general, I agree. Taxes are a secondary concern, particularly for those who use stocks for charitable giving. Donating appreciated stock is a home-run strategy for those with long-term capital gains.

Not paying attention to your investments.

This is true. If you can’t evaluate you own investments, you should get a professional to do so. By professional, I mean someone trained to understand how investing works, because few truly get how it works. They should at least hold a CFA Charter, and hopefully show some competence beyond that to show that they have transcended the training of one with a CFA Charter.

My main points to you are these:

  1. Don’t look through the rearview mirror. Look through the windshield, and pick the stocks that offer the best returns now.
  2. Only buy a new stock when its implied returns are better than most stocks in your portfolio.
  3. Only sell a stock in order to fund a new stock with better implied returns.
  4. Good investing is a lot of work. If you can’t do it, get a professional to do it for you.
  5. Consider taxes to the degree that it makes sense, and donate appreciated stock when you can.

The author’s six investing errors have a modest amount of merit, but the intelligent investor is dynamic, and adjusts to changing market conditions. Your assets should be managed by those who are similarly dynamic, if you can’t do it yourself.

About David Merkel 144 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com (http://www.RealMoney.com). Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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