5 Dangerous Investment Ideas

The stock market can be a wonderful thing, helping you grow your wealth and enjoy a comfortable retirement. But it can also fry your precious nest egg if you're not careful. My colleague Morgan Housel has noted that the financial industry "is dominated by cranks, charlatans, and salesmen" -- but very often, we're the ones who most endanger our portfolios and our financial futures with our reckless investment ideas. Permit me to review just a few.

"Wow, this cheap stock is only $0.13 per share! I can buy 10,000 shares for just $1,300!"
Penny stocks -- those trading for less than about $5 per share -- are usually very bad investment ideas, as they can be easily manipulated and are often tied to shaky, unproven companies. Sure, they entice us with their seemingly cheap prices, and the thought of owning 10,000 shares of something is somehow more exciting than owning far fewer shares. But a low price isn't necessarily a cheap price. A $200 stock can be undervalued and more likely to rise than fall while a $0.13 stock can be worth much less than that and be more likely to fall than rise.

"This is the stock in which I have the most confidence. I'm going to buy some as soon as the price drops a little."
Many investment mistakes we make are things we didn't do instead of things we did do. If you're ready to invest in a stock because you have great faith in its future growth and believe that its stock is undervalued, then consider just going ahead and buying it, instead of hoping to snag a slightly better price for its shares. After all, if it's such a great buy, others might be thinking the same thing and may snap up shares, resulting in the stock never falling to your hoped-for price.

It is a good investment idea to wait for a better price if you think a stock is overvalued. Just aim to buy stocks when they seem like bargains, given their growth patterns and promise and their valuation measures such as price-to-earnings (P/E) ratios, price-to-sales ratios, price-to-cash-flow ratios, and so on.

"I'm going to load up on my employer's stock. After all, I know more about this company than any other."
Another of the most dangerous investment ideas is buying a lot of your company's stock. It does seem like a good idea, as most of us tend to understand our employer better than we do other companies. But consider this: Your employer is already responsible for much of your financial security, as it provides the income on which you live. Most of us can't diversify our work across many companies. We have most or all of our income eggs in that one basket. So if you then entrust much of your stock portfolio to that same company, well, you're taking on a lot of risk. Think of Enron and Lehman Brothers and other companies that essentially went out of business or saw their stock values vaporized. Employees heavily invested in them lost much of their savings -- at a time when their jobs were in jeopardy or lost, too.

"This guy on TV sure is making a great case for this stock. I think I'll buy some."
Beware of financial commentators or money managers who appear on TV (or in print, for that matter) touting their investment ideas. It's easy to make a compelling case for most stocks, as you can simply leave out negative factors or red flags. Some of these folks are making recommendations that will serve you very well. But others will flame out. Remember that you rarely know the full performance record of these folks, and even the worst of them will have some successes. Meanwhile, truly smart stock pickers will make occasional bad calls. No one is perfect. Meanwhile, even stock analysts are not necessarily looking out for your best interests, either.

Take responsibility for the investment ideas you act on, and if you discover a seemingly compelling stock somewhere, don't buy into it without doing further research on your own. Make sure the company is healthy and growing, that it has solid competitive advantages, and that it's trading at an attractive price that offers some margin of safety. If you're not sure, add it to your watchlist as you keep learning more about it and perhaps as you wait for a more attractive price. This advice applies to investment ideas you get from friends and relatives, too, in the form of hot stock tips.

"As soon as I make my money back on this lousy stock, I'm selling."
Finally, another of the many dangerous investment ideas out there is a common one -- waiting and hoping for a fallen stock to recover. It's natural: Your stock plunged, and rather than sell it now, you'd like for it to rise a little or a lot, to recoup more or all of your loss. If the company is healthy and growing and you still have great faith in it, waiting does make plenty of sense. After all, many great companies see their stocks slump now and then.

But if the company's problems seem long term instead of temporary, and if the stock is no longer among your best investment ideas, you're probably best off selling it. Yes, you'll take a hit. But think of it this way: If you lose $2,000 and are left with $3,000, you can either make some or all of that loss back in the stock in which you've lost faith or you can sell and move the $3,000 into a stock you're very bullish on. Your goal is to have that $3,000 grow -- won't it have the best chance of doing so in your best investment ideas and not ones about which you're doubtful?

The more you learn about investing, the better your investing ideas will be. Stick with the good and avoid the dangerous ones. Your portfolio will thank you.

 

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  • Report this Comment On June 27, 2013, at 11:02 AM, timc1981 wrote:

    "This guy on TV sure is making a great case for this stock. I think I'll buy some."

    But those guys on TV seem so smart...

  • Report this Comment On June 27, 2013, at 7:07 PM, LeeG3 wrote:

    Not to rain on your parade but there are exceptions to every rule. For example, when the car companies were in trouble, I would have bought Ford after it had dropped below $2 a share. I didn't, not because it was a penny stock at that point, but because I was worried that if GM and Chrysler went bankrupt, that would take the supplier network down and Ford couldn't produce its cars. Didn't happen but it was too big a risk.

    So low price can be a factor in the decision process but should not be the only factor. I would have made a lot of money as Ford went from $2 to $12+ in a very short period of time if it had met my other conditions for buying it.

  • Report this Comment On June 27, 2013, at 7:47 PM, tomd728 wrote:

    "I like this stock very much. What I will do is double my position now that it's down 50 % from my initial purchase. The worst that can happen is I sell after a 50 % gain from here and I'm even ".

  • Report this Comment On June 28, 2013, at 11:54 AM, Jurobi wrote:

    For the second statement, instead of waiting for it to drop to the price you like, sell a put on it at that price. It might not drop, and you keep the premium. It might drop to just below the price you want, but within the premium, so your effective cost is less than you would have paid. The worst case is that it drops below thee combined price and premium, then you get assigned the stock at the strike price anyway, But you wanted the stock, right? You're just starting at a loss.

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