Wednesday, July 25, 2007

Five Ways To Lose Money From Investing

There a lots of ways to lose money from investing. More ways than there are to make money :-) Here are five ways of losing money which I have seen happen (either to me or people I know.):

Buy a hot tip. Especially in rapidly rising markets, everyone seems to have a recommendation, based on unique or proprietary knowledge. Friends, colleagues, neighbors, and acquaintances will have stories of making thousands of dollars in a short time (days or weeks) on stock XYZ.

I confess I have purchased hot tips about ten times, with dismal results.

Buy an IPO. Initial public offerings (IPOs) have been occurring at a rate of 200 -400 per year. 37% fail in the first ten years. Also, many do not make money for the post-IPO shareholder, because the price declines or stays flat after the IPO. Although there are great examples of making money with IPOs, (e.g. GOOG, ICE, BIDU), more often than not, people are lucky to recover their investment.

A good strategy is to wait one to six months after the IPO to determine performance. I was able to buy ICE at a lower price at one month. However, I paid 5 times the IPO price for GOOG at one year after the IPO. Both stock gained at least 25% over the purchase price.

Buy when everyone claims to be making BIG money. When your neighbors and colleagues tell you about how they have made lots of in the stock market, there is always an urge to participate. I recall a colleague telling me how he made $60,000 in one day on a tech stock, since it rose 60 points in one day. Luckily, I wasn't tempted and the tech bubble burst within a year.

Currently, there is a lot of skepticism about the market. So I am not too worried about irrational exuberance at this time.

Use only high risk strategies. Buying penny stocks, trading derivatives, and buying/selling futures are examples of high return for high risk. Often these types of investments results in significant losses for the novice investor.

I have not traded in penny stocks or futures. I use a small amount of my portfolio to trade derivatives, primarily call and put options.

Use systems that claim to have big returns. In respected publications, such as the Wall Street Journal, I see advertising about systems that report returns of 20%, 100% or even a 1000%. They often include testimonials from "normal" people who have made those types of returns from the system.

I've never purchased one of these systems. If it is such a good system, why they are selling it to me for $99.95, with a money back guarantee? There's a reason they are selling the system instead of using the system to make their money :-)

Investing can be an expensive education. Avoiding these higher loss probability strategies can make investing more profitable.

For more on The Practice of Personal Finance , check back every day Wednesday for a new segment.

This is not financial or investing advice. Please consult a professional advisor.

Copyright © 2007 Achievement Catalyst, LLC


Anonymous said...

All good tips! Except number three... yes, it's definitely true that if a stock just shot through the ceiling you do not want to buy it that day. The conservative wait until at least the 25 or 50 day moving average before buying a stock.

However, simply not investing when anyone is making money is crazy! There have been bull markets that have lasted nearly two decades. If you sat out because everyone was making money, you'd have missed a very strong market.

Shifting Sands said...

A lot of sound advice there for newbies to take seriously. I wish I had read your post a couple of years back when I stared investing... u deserve some link love for this...

Super Saver said...

@ Jon,

Thanks for your comment.

Good point on number 3. As written, it does not clearly express what I intended. I will revise to "Buy when everyone claims to be making big money."

@ Raj,

Thanks for your comment and the link.

I probably would have still made the hot tip mistake even if I had received the advice as a new investor. Sometimes, it's too hard to resist a hot tip from a source who has made money on the stock :-)

zacharyfruhling said...

I'm all about index funds myself. Using an index fund portfolio will avoid most of these investing traps.

JJ2000426 said...

A great opportunity in SWC, which had been battered down 25% in 4 days by a desperate concentrated short who is unable to unwind its huge short position. Expect some great resersal tomorrow because this is one absolutely oversold stock with very bullish fundamentals.

I have done my research and explained everything about this concentrated short. Follow my link and do your own DD.

This is a rare opportunity you do NOT want to miss tomorrow. At least 10% profit in one day!!!

Super Saver said...

@ Zachary,

Thanks for you comment.

Your insight is a good one for new investors. Mutual funds are a good way to avoid the trap if one stays with a market index fund. The same traps can happen if one chooses sector or specialized index funds and trade freqently.

@ JJ2000426

Thanks for your comment.

It appears to me that your comment is a good example of four of the ways the post described to lose money: 1) Hot tip; 2)Claim of making big money; 3)High risk; and 4)System that claims high returns.

Although I will not invest in this stock, I will be interested in seeing how your predictions unfold :-)