I don't know about you, but I've done some pretty dumb things with my own money. In my younger days I gambled in Las Vegas casinos and lost money, and more recently I've made some pretty poor stock purchasing decisions by buying into clearly questionable companies and ignoring the tell-tale warning signs that were present.
But the great thing about each and every failure is that it's a learning lesson meant to keep us from making the same mistakes over and over again. Clearly, I'm going to make mistakes going forward, but the ultimate goal should be to profit from those mistakes so they become fewer and more far between.
The reason I even bring my own personal money mistakes up is that data released a few days ago by Thompson Reuters' Lipper research service shows that $43 billion was removed from U.S. mutual funds in the previous week. It's quite plausible that the majority of these withdrawals had to do with the possibility of a debt default, which was thankfully avoided, but it also represents the biggest investment outflow we've witnessed in more than two years. With the S&P 500 near an all-time record high, it's evident that investor uncertainty and skepticism could be boiling over.
This means there are countless investors out there right now searching for their next investment opportunity, and therefore plenty of opportunities for mistakes just waiting to happen. My goal today is to pass along some of the things I've learned from my investing past and help you avoid making some costly long-term mistakes. Here are what I believe are the five worst things you can do with your money right now.
1. Buy a CD
The allure of a certificate of deposit, better known as a CD, is simple: It offers a guaranteed rate of return in exchange for a commitment of investment with a bank, thrift, or credit union for a specified time (often ranging from as low as one month and as long as 10 years). The key words there for most folks is "guaranteed rate of return."
The problem with CDs right now is that their guaranteed rate of return is dictated by interest rates, and lending rates are still near historic lows. A quick pass at my own bank, Chase, earlier this week yielded some almost laughable return figures. Currently, a 12-month CD for any amount between $1,000 and $9,999 would earn you 0.05%. That's not a misprint. That's five hundredths of one percent! That means a $9,999 CD would net just $5 in a year. Although you're making money, the average increase in inflation over the past 100 years has been in excess of 3%. In other words, you'd be gaining $5, but losing badly to inflation in real dollars.
2. Buy penny stocks
It doesn't take much to be tempted by the allure of a penny stock. Every month it's not hard to find a highly touted over-the-counter Pink Sheets penny stock that's doubled or perhaps tripled in price despite a lack of news. Like winning the lottery, it inspires a feeling of invincibility among traders that you can't possibly go wrong. But make no mistake about it: They aren't smart investment vehicles.
Penny stocks on the over-the-counter board or the Pink Sheets are there for a reason -- they don't meet the stringent listing requirements set forth by the NYSE, Nasdaq, or S&P. You might overlook these listing requirements without so much as a pause, but these requirements are vital to your understanding of a business. The Pink Sheets have no requirement that companies file quarterly reports or business updates with the SEC. This means there's practically no way for you as an investor to get up-to-date information on the financial health of most penny stocks, or even learn the basics of what they do and how much cash they have in the bank. Furthermore, penny-stock companies are allowed to hire promoters to pump up the credibility of their company. Thanks, but no, thanks.
3. Buy a bond mutual fund or bond ETF
Similar to CDs, bonds offer investors a nearly guaranteed rate of return over a specified time limit. The difference between bonds and CDs is that most bonds aren't backed by the full faith of the U.S. government, which means there's always the possibility of a default and loss of your investment (although it's quite rare).
Bonds certainly offer investors better yield potential relative to CDs, but they also carry with them the potential for long-term underperformance in the current interest-rate environment. When interest rates remain low, bond mutual funds and bond ETFs such as the Vanguard Total Bond Fund (NASDAQ:BND) remain attractive because their yields of 2%-3% compare very favorably to a 0.05% annual CD yield. But the one thing you must never forget about bonds is that bond prices and yields move in opposite directions. It's probably fair to assume that at some point in the next few years, interest rates are going to bounce off their historic lows, which means bond prices are going to fall. So while your bond mutual fund or Vanguard Total Bond Fund yield may rise, both are likely to lose value as bond prices fall, more than negating your gain in yield.
4. Buy a primary residence as an investment
I'm sure I'll get plenty of gripes with this one, since the housing market has been a gigantic source of income for some of the world's wealthiest investors. Yet over the long run, buying a house has been shown to statistically be a poor investment.
Let me clarify this by stating that I'm not talking about buying investment properties that you plan to rent out, or even purchasing your first home to live in. If you want to buy a house to live in, assuming you have the funds for it, buy that house! All I'm saying is that if you're buying your first home with the expectation that it's going to make you rich, you're probably going to be sorely disappointed.
According to Robert Shiller who looked back at inflation-adjusted home prices between 1890 and 1990 in his book Irrational Exuberance, he found that inflation-adjusted gains per year totaled just a measly 0.21%. It wasn't until the past decade that home prices really took off, but that seems to be more of an anomaly than a changing of the guard in the housing sector -- the point being that your home is a place to live in, and it shouldn't be counted on as an investment.
There probably isn't anything more dangerous for your retirement than doing nothing at all. It's OK to sit on your cash from time to time and evaluate your investment opportunities, but squirreling money away under your mattress or a checking/savings account is no way to get ahead over the long term.
The reason here, again, is that while you're not losing money in nominal terms, your savings are being eaten alive by inflation. With inflation averaging 3.6% since 1913, you need to double your money every 20 years just to keep pace! If that money is tucked under your mattress where it's earning nothing, or sitting in a checking account that earns 0.01% annually, you're not doing yourself any favors.