Last month, we discussed what investors should be doing in this somewhat difficult market environment. This month, we address what investors should not be doing.
Like it or not, there are human nature hang-ups that can be serious hindrances to rational investing.
• “If I get even in that stock, I am getting out.” First, ask yourself if you would buy it if you had cash instead of the stock. If the answer is “no,” then get out. If the answer is “yes,” then by averaging your cost, you could sell at a break-even or even at a profit sooner. A stock bought at $20 that falls to $10 has to pass $15 on its way to your old break-even point.
• “There’s no way I’ll buy back the stock that I sold at a loss, especially at a higher price than where I sold it.” If you are using solid fundamental research on the stock, and if one or more of the fundamentals has changed to the positive, then think in terms of the profit potential from that point on. Circumstances can, and do, change.
• “My dad/aunt/grandfather/etc. told me to hold on to this stock, and I said I would.” This one is tougher than most, as it is a strong emotional tie – not to the investment value of the company but to the memory and promise attached to it. A classic example in the St. Louis area was Anheuser Busch, with many widows or children or grandchildren holding with no intention of violating their “never sell” promises. Often, it meant that the issue was a disproportionate percentage of their portfolios, precluding owning other good companies. The decision was made for the descendants by the InBev buyout.
• “If I sold, the taxes would be huge because I have such a large profit.” The maximum federal tax rate for long-term capital gains is 15 percent – at least through 2010, with the outlook for years 2011 and beyond uncertain but likely to be at least 20 percent. It isn’t going to get better than it is now. The investment merits, not the tax implications, should drive your decision.
• “My company has a thrift plan that lets me buy company stock, so that’s where I am putting my money.” This one is really scary. If something unforeseen happens to the company and – bam! You’ve got a real problem. Think Enron or WorldCom.
• “I’m going to buy an index fund and not worry about owning stocks.” There are two problems here. An index fund is a portfolio of – you guessed it – stocks. And if it’s an index fund of, say, the S&P 500, it is limited to U.S. holdings, thus not providing an investor with any asset allocation in other countries or regions. Be certain you are well-diversified across asset types and styles.
• “I’ve had it with stocks. I am putting my money in bonds.” This was a good idea two years ago as interest rates began their steady decline, driving bond prices upward. The probability is that interest rates will rise, driven by either the Fed or, before Fed action, the markets. As rates rise, bond prices fall, meaning a loss of principal if they are sold before maturity or a loss of purchasing power on an inflation and tax adjusted rate of return if they are held to maturity.
• “I’m going to hold my cash until I see the economy/unemployment/new home sales/whatever improve.” There is no better example of the market as a discounting mechanism than the movement it has made since the March low, when the economic, unemployment and new home sales were abysmal. By the time the “all clear” is signaled, the bulk of the profits will have been realized. It pays to look not at where we were or are, but where we’re going.
Clark Davis is a 37-year investment veteran and CEO of St. Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.
