1. Don't overcommit to the hot sector
Was it only November 4 that The New York Times listed Merrill's write-down of $8 billion on its subprime derivatives portfolio as the biggest in Wall Street history? That record only lasted until Nov. 5, with Citigroup's
Apparently, after seeing others make big money off the subprime mortgage market, top management at Merrill and everywhere else went into it in a very big way. However, by last year, everyone was getting in right at the end of the money train.
Jumping into what has already performed well -- with the hopes that the immediate future is going to mimic the immediate past -- is a very common investing mistake. It's what had mutual fund investors flocking into tech funds loaded with pricey shares of Amazon.com
Some developing-market funds, still up dramatically over the past three years despite a slow start in 2008, containing names such as PetroChina
2. Don't pay management too much
Merrill rewarded Stanley O'Neal, its CEO until late October, with an exit package worth about $160 million. This appears to be compensation O'Neal was contractually owed no matter how poorly he performed.
Outrageous compensation packages are par for the course on Wall Street, and they point to other commonplace outrages -- namely, the amounts that mutual fund managers get paid. Management fees come directly out of shareholders' potential profits and average more than 1.5% per year. High annual fund expenses bear an extremely high correlation with fund underperformance. When investing in funds, don't be like Merrill; find managers that are taking a reasonable cut for reasonable pay -- less than 1.0% annually.
3. Be very careful when you buy advice
Somewhat lost in the headlines is that Merrill has advised 100 of its pension fund clients that the SEC is investigating its pension reference business. To make a long story short, Merrill consultants are being investigated for steering clients toward pensions without properly advising them about potential conflicts of interest from taking a big cut from the pensions for the "services." Surprise! That's the exact practice that has led to broker-sold mutual funds drastically underperforming funds chosen by individuals without the "help" of brokers.
The Foolish bottom line
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This article was first published Nov. 12, 2007. It has been updated.