Not all advice is worth taking, but that doesn’t mean all advice is worthless. Although it can be tough to know you’re getting good advice, there are some ways to know if you’re getting bad investment advice. That’s critical when you’re looking to get that perfect buy scenario.
Every interested investor wants to achieve the equivalent of buying Facebook Inc (NASDAQ:FB) when it fell below $20 per share or picking up Microsoft Corporation (NASDAQ:MSFT) at the time of its 1986 IPO.
However, with the amount of advice available and a large number of financial advisors, finding these high returns can become a confusing process. Although finding massive profits will remain challenging, knowing what not to do when investing can help immensely. Investors will serve themselves well by avoiding these pieces of bad investment advice.
Bad Investment Advice: Go with Your Gut
No matter how much research one does or how adept investors become at analyzing financial statements and charts, the single biggest challenge every investor faces is emotion. People in the throes of depressive lows or dopamine-induced highs tend to make poor investment decisions. In fact, these emotions usually tell investors to buy high and sell low.
The excitement about cryptocurrency led people to buy bitcoin at $19,000. Emotions also told investors to sell retail stocks last year as the narrative that Amazon.com, Inc. (NASDAQ:AMZN) was “taking over retail” led everyone to sell stable retail stocks such as Costco Wholesale Corporation (NASDAQ:COST) or Kroger Co (NYSE:KR).
People who bought Costco and Kroger at this time saw decent returns. However, the feeling at the time sent signals that these companies were going to fall victim to Amazon. Still, buying a stock when emotions are telling everyone that it is headed for $0 takes a great deal of courage.
It took the same kind of courage to sell tech stocks in 2000 or financial stocks in 2007. Incidentally, this is why I have gone against most of my InvestorPlace colleagues when I encourage people to sell Amazon.
Becoming a profitable investor requires the courage to prioritize PE ratios and dividend yields over feelings. This Warren Buffett quote summarizes the issue well:
“Be fearful when others are greedy and greedy when others are fearful.”
Do not just read the quote. Becoming a good investor means knowing this quote in the deepest recesses of your mind, and of course, leaving your comfort zone.
Bad Investment Advice: Invest in What You Love
One other emotion-based investment decision I discourage is buying stock in the things you like. We all have products and experiences we enjoy on a personal level.
Costco has become one of my favorite stores. The fact that they usually sell the lowest-cost gas in town brings me there. When I visit the store afterward, I enjoy sampling the foods they sell and browsing their new and interesting products. I leave the store with the feeling that I received a lot for my money.
Ironically, the value I derive from the Costco store has turned COST stock into a less-appealing offering. I still think Costco stock will rise in the long run. However, the time to buy was a year ago when fear of Amazon hit a fever pitch. Today, at 30 times earnings, I can find a better bargain in a different equity.
The same applies to my other tastes. I will sometimes flavor food with ketchup or other sauces. However, Kraft Heinz Co (NASDAQ:KHC) stock will likely leave a bad taste in your mouth.
I like Modelo Especial beer. Still, the erratic profit growth and the low dividend will keep me from popping open a position in Constellation Brands, Inc. (NYSE:STZ) stock. Conversely, I usually recommend Spirit Airlines Incorporated (NYSE:SAVE) for those who want to buy an airline stock. However, my experience flying Spirit was less enjoyable.
We all have products and services we enjoy and dislike. Just keep in mind that shopping for stocks should be judged by different criteria.
Bad Investment Advice: Diversify, Diversify, Diversify
Diversification is not always bad advice. In fact, going all in on one stock usually does not end well for investors. Investors simply have to learn and how to diversify.
I like diversification when it comes to 401k or IRA money. When saving for retirement safety becomes more important, particularly to investors nearing the end of their working lives. Moreover, most 401k investors have little interest in following the stock market.
For these investors, my favorite diversified investment usually means a market index such as SPDR S&P 500 ETF Trust (NYSEARCA:SPY). Through euphoric bull markets and deep depressions, the S&P 500 index that the fund tracks has yielded a 9.8% average return over the last 90 years. Moreover, its expense ratio stands at only 0.09%.
For every other type of investor, education should replace diversification. Your experience reading InvestorPlace articles can be greatly enhanced by understanding how to read both financial statements and charts.
Knowing both the benefits and limitations of the price-to-earnings (PE) and other ratios also helps. Also, learn where to find information on revenues and income and predictions on future earnings. That way you can calculate ratios on your own.
Also, understand the power of psychology, both your own and that of the market. People want to buy Amazon at over 200 times earnings. However, Micron Technology, Inc. (NASDAQ:MU) struggles to gain traction at a PE ratio of seven.
Despite the disparity, both equities enjoy high growth rates. With little numerical justification for the difference, psychology is the likely reason for the different valuations.
Investments constantly change, and investors have to be willing to adjust to changes. I would never recommend putting all your money into one stock. Still, if one knows the financials and the psychology behind them, investors can get away with less diversification.
The Bottom Line
Parsing through all of the bad investment advice has become a daunting task for investors. Much of the bad investment advice can even sound good, particularly to a novice. However, avoiding emotional decisions such as making only comfortable choices or only buying what you love will filter out much of the noise.
Moreover, if investors know when to diversify, they can both protect themselves and open their portfolios to the possibility of massive gains.
The internet era has brought people large amounts of investment advice. However, knowing how to filter out lousy advice can greatly help in replacing confusion with profits.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.
