I've written before about how to make millions from thousands, but I think it's also valuable to understand how you might do the opposite. Even if you're not yet a millionaire, the wrong moves could still turn your thousands into hundreds.
The CFA Institute, which grants very respected "CFA" designations to financial analysts who pass its series of rigorous tests, recently released a list of 12 common investing mistakes. Here are three errors particularly worth avoiding.
1. If you fail to plan, plan to fail
Many of us have significant portfolios filled with a variety of investments. We buy this stock because it looks good, and that stock because we read about it somewhere, and this one because it sports a hefty dividend, and that one because it's growing quickly. But do we have any overriding strategy? Nope.
When will we sell any of these stocks? We don't know. How long do we aim to hold them? We don't know that, either. How, exactly, do they fit into our Big Plan? Unfortunately, we don't have one.
All the great investors place their money according to some underlying strategy. Many believe in value investing, buying each stock only a certain discount to its fair valuation. Many are long-term investors, aiming to hang on to their stocks for years or decades, as long as those investments remain promising.
These folks know how much risk they can stomach, and they won't exceed that limit. When the market tanks, as it did in 2008, they don't sell in a panic like so many lesser investors. They know their strategies, and they stick with them.
2. Don't place all your eggs in one basket
Do you own shares of Pfizer (NYSE:PFE), because you're excited about its blockbuster drugs, its pipeline, and its seemingly attractive valuation? Great. But do you also own Merck, Bristol-Myers Squibb (NYSE:BMY), and Abbott Labs? And do they, together, make up 40% of your portfolio? If so, then you're heavily concentrated in the pharmaceutical industry. If it suddenly plunges -- say, because of new health-care-related legislation -- you'll be in trouble.
You need to spread your assets over a variety of industries -- and, ideally, over a variety of geographical regions and asset types. American stocks have a great track record, in general, but many other economies are growing more rapidly. Even those that aren't may buffer you a bit, should the U.S. economy falter. By investing in several different asset types, you'll also reduce some of your risk, and be able to enjoy a greater variety of benefits from different global markets.
Large, established dividend payers such as AT&T (NYSE:T) and Procter & Gamble (NYSE:PG) offer a benefit of their own: the one-two punch of expected stock price appreciation, coupled with growing dividend payments. Even when the overall market is slumping or stalled, their payouts keep rewarding you.
Smaller companies, such as NVIDIA (NASDAQ:NVDA) and Intuitive Surgical (NASDAQ:ISRG), rarely pay a dividend, but they do offer greater growth potential. By daring to defy conventions, these Rule Breaking companies can grow extremely rapidly. (I've tripled my money on Intuitive Surgical in just a year or two.)
3. Buy only at the right price
Even a company that's obviously terrific, healthy, and growing rapidly can be a terrible investment at the wrong valuation. If a company's intrinsic value is around $100 per share, but it's trading for $140, it's more likely to fall in price than continue its ascent.
It's true that some highfliers, like classic Motley Fool Stock Advisor pick Amazon.com (NASDAQ:AMZN), have always seemed overvalued, yet still kept appreciating. But there's no guarantee that Amazon's growth will continue, nor that all rapid growers will follow its example.
To avoid overpriced stocks, look at measures such as P/E ratios and price-to-sales ratios at the very least. Compare them with the company's historic averages, with those of its peers, and with the company's revenue growth rate. For an even more accurate picture of a company's value, check out its free cash flow and other measures of profitability.
Be the best
The smartest and most successful investors keep thinking and learning about investing. They figure out what mistakes they've been making, and avoid repeating them. They develop strategies andstick with them, diversify effectively, and buy at compelling prices. Be one of those investors, and you'll do well.
Our Motley Fool Stock Advisor team looks for the best companies across a variety of industries and company types. Take advantage of a free, no-obligation 30-day trial of the service, with full access to our entire archive of previous picks. It just might help improve your chances of turning thousands into millions.
Longtime Fool contributor Selena Maranjian owns shares of Procter & Gamble and Intuitive Surgical. Pfizer is a Motley Fool Inside Value recommendation. Intuitive Surgical is a Motley Fool Rule Breakers pick. Amazon.com and NVIDIA are Motley Fool Stock Advisor selections. P&G is a Motley Fool Income Investor pick. The Fool owns shares of P&G. The Motley Fool is Fools writing for Fools.
