Every investor slips on a banana peel now and then. (Even Warren Buffett took $1.4 billion of write-downs in 2010 and 2011 on some Texas utility bonds he bought during the mid-decade energy boom.) But some errors can easily be avoided — if you’re willing to follow a few basic rules and use common sense.
Here are five bloopers to avoid in the New Year. Correct your game, and you’ll be richer for it in 2013.
1: Listening to the Wrong Voices
Let’s cut to the chase. The biggest gaffe investors make is following the wrong advisers. I’m not saying you should listen only to me. Quite the contrary. I gather my investment ideas from a multitude of sources, and I encourage you to do the same.
Certain traits can help you decide whether someone is worth heeding. Does the adviser build a logical case on facts or resort to sensational rhetoric? Does the analyst frankly acknowledge risks?
Gurus who affect an air of infallibility don’t deserve your time. Nor do the screamers on CNBC and various Internet video channels. Tune them out, and you’ll improve your results.
2: Trading Too Frequently
I’m not opposed, in principle, to a certain amount of tactical trading, particularly when a stock or a market sector becomes overextended.
But unless you’re a professional trader, glued to the ticker, you shouldn’t attempt to buy and sell in rapid succession. The profits are too small and too easily erased by random events (to say nothing of brokerage commissions and other transaction costs). Day trading, especially, is best left to institutional investors who deal in giant block orders. For those folks, a fraction of a penny per share can amount to real money.
Despite the poor odds in day trading, numerous TV shows and subscription services lure the unwary to try their hand at it. Don’t fall for the ruse! Your average holding period should be measured in years, not weeks or days.
3: Inertia in the Face of Opportunity
This is the opposite of trading too much. When markets have been trending in one direction, it’s easy for investors to get too comfortable.
I see a big reversal coming up in the consumer discretionary sector. Fund managers have poured hundreds of billions of dollars into darling stocks like Amazon (NASDAQ:AMZN), Comcast (NASDAQ:CMCSA), Home Depot (NYSE:HD) and Priceline (NASDAQ:PCLN). Meanwhile, consumer incomes are growing slower than in any economic recovery since World War II, revealing a huge disconnect between the stocks and their fundamental driver. If you own any of these names, I urge you to exit now.
Make it a New Year’s resolution to fight off complacency. Surround yourself with advisers who scan the horizon for signs of impending change so you’ll be ready to act promptly.
4: Overpaying for Financial Services
Back when the stock market was gaining 20% year after year, you didn’t have to worry much about expenses. These days, though, high brokerage commissions and management fees can take an intolerable bite out of your returns.
If your full-service broker is giving you great advice and service, by all means stay put. If you’re not getting good value, however, take your business elsewhere. My favorite all-around discount broker, TD Ameritrade, charges only $9.99 for equity trades. TDA also offers stock research from Credit Suisse, a top-tier investment bank.
Among mutual funds, I’m wary of any with higher expenses than its peers. (You can check the annual expense ratio of most at www.morningstar.com.) As a rule of thumb, I prefer domestic stock funds with expense ratios of 1% or less. In bond funds, Vanguard’s are nearly always the cheapest. Where possible, I recommend substituting exchange-traded funds for actively managed funds because ETFs typically carry lower overhead.
Some investment products, such as options and commodity-linked ETFs, are freighted with hidden costs. Avoid these vehicles except for short-term trades.
5: Taxed to Death
As I write these words, it’s still uncertain how President Obama and Congress will deal with the fiscal cliff. Nonetheless, I can say with almost complete assurance that taxes are going up in 2013.
Take advantage of every deduction you can. In 2013, self-employed people with sufficient income can contribute up to $51,000 to a SEP-IRA. Every penny you kick in reduces your taxable income.
On the investment front, earn as much income as possible from tax-exempt and tax-sheltered sources. Municipal bonds, with their tax-free coupons, are worth considering. However, given their low yields, I’m inclined to hold rather than buy right now.
Master limited partnerships offer a more fertile field — especially my favored i-units, Enbridge Energy Management (NYSE:EEQ) and Kinder Morgan Management (NYSE:KMR). I expect both to chalk up a total return of 15% to 25% in the coming year.
Nobody said it would be easy. But avoid these five errors, and you’ll lay a prosperous financial foundation for yourself in the New Year.
Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk “value” approach has won seven “Best Financial Advisory” awards from the Newsletter and Electronic Publishers Foundation.