How to Avoid Making Costly Investing Mistakes

Right now, the problem in the stock market is uncertainty. Here’s how to avoid costly investing mistakes.

This is a difficult market for everyone―traders and investors alike. So how do you keep from making investing mistakes?

With so much at stake and no way to know how things will ultimately play out in Washington, the question is not whether you’ll make mistakes, but how to keep from making the kinds of mistakes that will have a long term effect on the quality of your lifestyle.

A good first step is to work with a professional Private Wealth Advisor who can help you develop a comprehensive Private Wealth Design. I suggest looking for someone who is a certified financial planner (CFP®) that works on a fee-only basis. Consider steering away from friends and family members, as they may have a hard time providing advice.

What Are Your Financial Priorities?

When you’re ready to get started, it may be helpful to boil things down into three separate areas:

Survival. Things you need for basic living and can’t live without such as food, clothing, and shelter.

Lifestyle. These are discretionary and luxury items such as a vacation home, transportation, travel, and entertainment.

Legacy. Things you want to leave behind for the benefit of others.

Put enough money into each of these areas to cover your costs regardless of the performance of the markets in the short term. This is especially important for the survival portion of your assets, which you don’t want to take risks with. Survival monies should typically be invested in strategies that offer some level of security against loss. This doesn’t mean that you have to invest only in short-term vehicles. You may also want to consider longer term investments.

You’ll be able to invest your lifestyle and legacy assets a bit more aggressively since you’ve covered your survival expenses first. To determine just how much risk you’ll be comfortable with, take stock of the costs associated with maintaining your lifestyle or luxury items. Then determine which luxuries you would be willing to do without. This gives you a sense for how much you are willing to risk should your investments decline in value.

In this piece, I intend to help you with the assets you can take more risk with—typically your assets invested in mutual funds and individual equities.

Are You an Investor or a Trader?

First, decide if you are an investor or a trader. Investors typically hold a position for an extended period of time or for specific fundamental reasons. Traders tend to hold securities for shorter time periods, seeking to get out of a position relatively quickly or after a percentage move up or down. Over the past few weeks, neither has fared very well. In fact, I believe the only investors making out right now are those who get paid for executing trades.

Recently, traders have been running into problems trading on whisper numbers. Whisper numbers are earnings estimates that investors talk about that are different from what analysts publicly post. Some companies offer subscriptions to services that provide this information. They all seem to claim market-beating results over an extended period of time, but from what I’ve seen, that hasn’t been the case in the past few weeks. Some companies announced earnings that beat the posted estimates as well as the whisper numbers. They then increased their guidance for the future only to experience a 10 percent drop in value. That hurts! Put two or three of those trades together, and you’ve put a serious dent in your risk capital.

If you’re an investor with a longer term investment horizon, while these kinds of trades can hurt performance, they don’t end up compounding the results. Your portfolio may be down, but the potential for future returns may have increased. This goes back to the belief that a stock’s future performance is driven by the estimated future earnings of the company.

So what’s going on? The problem is uncertainty, and at the time of this writing there is still plenty of it. While the government reached a deal on the debt ceiling, it’s not a permanent solution to the problem. In fact, they’ve essentially “kicked the can down the road.” There is much work to do over the next six months and through the 2012 elections.

In the meantime, I’ve seen an increase in advertisements from companies trying to entice investors to purchase their stock now in anticipation of an extreme market event. Rest assured that these companies will only make money if they can convince you to act, but more than likely you will only prosper if the extreme event occurs. Extreme events don’t occur very often. That’s why they’re called extreme events.

There are some positive signs out there that are not catching the headlines yet. The earnings that have been released from the companies in the S&P 500 Index are near historic record highs.

So don’t let your emotions get the better of you, leading you to make costly investing mistakes. Go back to your financial plan, take a look at your progress and make appropriate adjustments within your risk tolerance. If you’re a trader, the high level of uncertainty should soon pass, and you can get back to a somewhat normal trading discipline. If you’re an investor like I am, stick to your fundamentals and make transactions when those fundamentals change. Remember, when you prioritize your assets into survival, lifestyle, and legacy allocations, you can help ensure that essential needs are met while positioning your other assets for future potential growth.

Read this article on U.S. News & World Report >

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for individual. To determine which investment is appropriate please consult your financial advisor prior to investing. All performance references are historical and are not a guarantee of future results. Strategies involving asset allocation and diversification do not ensure a profit or protect against a loss.