Subscribe
It seems like over the past few weeks, the new call-ins to our office have come from investors
who have committed similar errors. Although common, some of these errors have severely
restricted their gains over the past few months, despite the huge run-up that we have seen in the stock market. To be fair, some of the mistakes these investors have related to us have been made by their advisors. That said, please don’t misunderstand that statement. Not every stock or mutual fund that we pick is a winner. However, there are certain errors that are easy to see coming and simple to avoid. Therefore, these are the ones that we will discuss.
“Mistake Number One, not knowing the costs of entering or exiting a mutual fund.” Generally
speaking, there are two different ways mutual funds can be marketed, either through a sales force
or directly to the consumer. Those that are marketed through the efforts of a sales force or
stockbrokers are referred to as loaded funds. These funds either charge commissions to get in or to get out. Class A shares are funds that usually charge a commission in the range of four to five percent of the initial deposit at the time of the deposit. Other mutual funds marketed by brokers or advisors levy fees if the fund is sold within a certain timeframe, usually seven years. These are known as Class B funds and carry an internal expense ratio that is usually one percent higher than would be otherwise. The final method of compensating the sales person of a loaded mutual fund comes from purchases of Class C funds. These funds typically levy a fee of one percent per year and is used to compensate the broker who sold the investment. In our opinion, this is the most cost efficient way to purchase a loaded mutual fund through a broker. However, the most cost efficient way is to invest in a pure no-load fund or one that levies no sales fee to get in or to get out.
Just a reminder, we believe the mistake the investor makes is not investing in a mutual fund
that carries a commission, but rather not being aware of how that commission may limit future
growth or investment flexibility should the investor wish to make a change that would include
another fund family.
Another mistake that investors make is what we refer to as “waiting to break even.” This occurs
when, shortly after making an investment, the security declines in price due to a company or
mutual fund specific problem or perhaps due to general market weakness. Many investors recognize that the investment they now have no longer is the one they thought they were getting into. It no longer is one they wished they had made. It no longer is one that they plan on holding to for a long time or one that they view as having a lot of potential. However, they tell us that once they get “even” or are no longer losing money in this investment they will sell. This is a
mistake. An investor must always ask his or herself the following questions. Would I make this
same investment now? Does this investment have worthy potential or am I better off investing
elsewhere? If the answer to those questions is no then you cut your losses immediately and
move on. Remember to recognize a couple of fundamental principles of investing. The first
being that you will always choose some losers. You can not invest without picking some
bummers! The key is to have more winners than losers. Remember, a .300 hitter in baseball
gets into the Hall of Fame even though he gets out seventy percent of the time. The second
fundamental principle of investing is to “sell your losers and let your winners run.” Don’t wait
to get even. You may be waiting a lifetime while the overall market passes you by.
To employ another baseball analogy, the final investment error that we will discuss will be
“swinging for the fences.” Many investors try to hit the home run by investing a great portion
of their money into little known or speculative companies in the hopes that they are buying into
the next Apple Computer or to find out some time later that their winner is a loser and that their
investment has gone belly up. As a result of years of experience, I have come to realize that
there is no information scoop or free lunch. We, like all other investment advisors have to work hard at researching and then making the right investment. Shrewd investors know that the obtainment of wealth is a process that demands time and patience. Sure, a few investors will strike it rich. However, to think that we will be as lucky is like saying that most of us have
a good chance to play in Major League Baseball. It happens only rarely. If you do wish to speculate, please do so with less than five percent of your portfolio and recognize that you may lose all of that money.
THE BOTTOM LINE. Know the cost of investing. Know how you are compensating your investment advisor. Finally, recognize that becoming a competent investor requires time, patience and that you will make mistakes along the way.