12 Common Investment Mistakes (And How to Avoid Them)

By Thomas W. Batterman

Today's Wall Street run-up has attracted millions of investors who seem to assume that the click of a computer key is nothing less than the Midas touch. In these heady times, it seems as if many have thrown caution to the wind.

Everyone has a story about this or that investment that brought them 20% or 30% returns. Obscured in the process are those investments that didn't do so well or maybe even lost money. The result is that portfolio growth is not what it should be despite the occasional euphoria of hitting a home run.

If you want to gamble with your financial future as if you were sitting at a blackjack table in Vegas, spend your time like the day traders trying to find the next home run. If you are serious about building wealth, you need to forget about the home runs; hit a bunch of singles and doubles with few strikeouts. Develop a solid plan with reasonable goals and expectations and then implement it prudently.

Here are 12 mistakes to avoid for those who are serious about accumulating assets over time. Taken together, these guidelines provide a road map worth following:

1. Having too much or too little in stocks. For some, protecting the principal is essential. But while prudence is always appropriate when investing, avoiding equities altogether is too conservative no matter what your situation. You need to grow your assets somewhat so that what you have protected will buy you as much in future years. The most conservative portfolio actually will have about 20 percent in common stocks, not zero percent as many believe.
   
   On the other hand, too much in stocks is too risky. For example, many who reach age 50 and realize they are behind in funding their retirement income seem willing to take greater risks to try to catch up. In other words, they "bet the farm." If the market moves in the wrong direction, they will end up worse off than when they started.
   
   A proper plan will develop a stock exposure which will allow you to tolerate negative stock performance periods without making you so nervous that you lose sight of your objectives and get nervous and bail out.
2. Not having adequate stock diversification. Ibbotson Associates, the investment research firm, points out that risk increases as the number of stocks in a portfolio decreases. About 25 to 30 individual stocks seems to be a minimum number required for adequate diversification and provides about the same risk protection as having 200 to 300 stocks. Mutual funds can serve the same purpose, of course. Diversification is needed to build wealth.
3. Avoiding international stocks. Many U.S. investors are uncomfortable with including international equities in their portfolios; but the fact is that two-thirds of the world's stock market capitalization is outside the U.S. Developed, efficient markets such as Germany, UK, France and Japan among others provide returns similar to U.S. stocks through different business cycles. The only difference with international stocks is currency fluctuation, which is essentially neutral in the long term. Including international stocks is a way to help avoid unnecessary volatility and increase long-term gains.
4. Using expensive mutual funds. Selecting mutual funds requires close attention since making the wrong choices can be costly over the long run. For example, some brokers are selling "no-load" funds with a high expense ratio. High expense no-load funds or load funds can provide you 25 percent less return over a 15-year period than a comparable lower-expense fund with the same performance of the underlying investments. You should strive to own the best performing "no-load" funds with the lowest internal costs.
5. Having fixed income investments coming due at the same time. Investors fairly commonly have most of their fixed income investments (C.D.s, U.S. Government bonds, Corporate or Municipal bonds) coming due within a fairly short period of time such as 12-24 months. This rapid repricing of the portfolio is handy if rates go up, but can really squeeze the incomes of those living on fixed income in periods of rate declines such as in the late 1980s and early 1990s. To stabilize your interest income over time, you need to diversify this "interest rate risk" by having no more than 20-25% of your fixed income investments coming due within any 12 month period.
6. Purchasing bonds with maturities that are too long. When rates are low it is tempting to extend maturities out an extra five,10 or even 20 years to get a little bit extra interest. While the additional interest you normally get paid by extending your maturities rises fairly sharply as you increase maturities from 1 to 2 to 3 to 4 years, the additional interest flattens quite substantially over longer periods. It is simply not worth the interest rate risk you assume in these longer investments to lock your money up for that long.
7. Buying poor quality bonds. Again, when rates are low it is tempting to reach for the higher interest offered by poorer quality bonds. But a default in payment on such a bond could easily more than offset any additional interest you might expect to earn. Remember, the issuer of the bond doesn't want to pay any more than they must to get someone to loan them the money. If they have to offer a higher-than-market rate to attract investor interest, there is probably a very good reason!
8. Buying preferred stocks as bond "proxies." Preferred stock, usually offering higher dividend rates than are available on then-current bond investments, are sometimes seen as substitutes for bonds. They shouldn't be. A preferred stock, unlike a bond, has no maturity! The value of your investment will generally rise and fall with the movement in interest rates after you make your investment. You will normally only "get back what you paid" when interest rates are at the same level as they were when you made the investment. And "straight preferred" (i.e., not convertible preferred) does not share in any of the growth in the company's value, so you have a bond without maturity with no upside potential unless interest rates decline! Convertible preferred performs and should be analyzed similar to a common stock investment, not a bond investment.
9. Buying annuities as investments. Fixed annuities often seem attractive because they offer initial rates higher than on what appear to be comparable fixed income investments. But this is normally an "apples to oranges" comparison. Because of surrender penalties which normally last for 7-10 years, this is essentially a 7-10 year investment and should be compared to the rates on other fixed income alternatives of similar maturities. If the annuity rate is still much higher, be careful; fixed annuities often offer a "teaser" attractive current interest rate as an inducement to buy the product. Once you are in, the interest rate can be lowered to the guaranteed rate - and you will be stuck with the undesirable options of accepting a substantially lower market rate or a hefty penalty to get out of the investment. And the tax deferral feature that is often touted as the annuity's big advantage may actually be a disadvantage. Many fixed annuity investors would be better off paying tax on interest as they go along or investing in tax-free investments instead of lumping the tax consequences of this interest up to be taxed in big chunks to themselves or their heirs at higher tax rates in the future.
   
   If you're thinking about a variable annuity, you should know that this is an investment in a mutual fund wrapped in an insurance contract. The costs of wrapping the annuity around the mutual funds takes a big bite out of your mutual fund return - most studies peg it at a 2-3% annual return reduction. While the gains on your investments in the annuity will ultimately be taxed as ordinary income, your gains on direct mutual fund investments outside an annuity will be taxed at much more favorable capital gains rates. The tax deferral should be a very big benefit to you to justify the use of such an investment.
10. Using annuity investments in an already tax deferred account. "Why would anyone want to do anything like that?" you ask. That's a good question. Unfortunately, it happens all the time. Many investors have purchased annuities as investments in retirement-type accounts such as IRAs, 403(b)s (commonly referred to as TSAs) or 401(k)s which are already tax deferred. There is no need to pay the extra expenses involved in an annuity investment when you are investing dollars that are already tax deferred. Direct investments in stocks, bonds, C.D.s or mutual funds inside these accounts will yield much better returns for you on an "apples to apples" basis.
11. Buying C.D.s from brokerage firms. Brokerage firms will frequently offer C.D. rates that are very attractive when compared with the C.D. rates of your local bank. But the cardinal rule of fixed income investing - if something is paying higher rates than it should, there is something you don't know and need to find out about before investing - applies here. Most brokered C.D.s have an actual maturity of 10-20 years! The bank has the option to call this investment away from you every year if it wants, and it will do so if rates have dropped and it can get money at lower rates. But if rates go up, you will be locked into this poor paying investment for much longer than you originally thought.
12. Making investment decisions based on media "advice". Look at the newsstands. The headlines on an attractive investment magazine scream "The 10 Best Mutual Funds" and "Three Hot Stocks." While columnists can play a role in getting people to think about their investments, these writers are not investment advisers. Their goal is to help sell magazines. While that's a worthy business objective, it rarely serves the best interests of the investor. Investing is serious business because it's about your future and that of your family. Your portfolio deserves thoughtful, prudent and experienced guidance that will serve your objectives over the long term.

While we hear about those who "make a killing in the stock market," it's not often that we hear about those who "got killed" because of unwise investing. While paying close attention to these 12 common mistakes will not assure success, avoiding them will go a long way toward following a rewarding path.

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Thomas W. Batterman, a Certified Trust and Financial Adviser and the Senior Relationship Manager for Vigil Trust & Financial Advocacy, Wausau, WI, has 17 years of experience in the financial advisory field. He is a licensed attorney and is a member of the National Association of Personal Financial Advisors. His firm, Vigil Trust & Financial Advocacy, was started in 1988 as the State of Wisconsin's only Fee-Only registered investment adviser with full corporate trust capabilities and is a founding member of the Association of Independent Trust Companies.