Nearly everyone sooner or later is bombarded with good advice on how to make a killing in the market. Uncle Abe loves high-risk, high-technology over-the-counter stocks. Aunt Zelda swears by the blue chips and never sells a share. Cousin Gordon never misses an opportunity to crow about how he bought gold at $375.
Because many people are novices when it comes to the vagaries of investing, they make serious and costly mistakes.
High-risk investments are one area where inexperienced or unsophisticated investors regularly get burned. More than three-fourths of all investors lose money in commodities, for example. So before you take a flyer in pork bellies, do your homework and be prepared for a wild ride.
The Times asked three veteran stockbrokers to list the 10 biggest mistakes small investors make and suggest how to avoid them. Their answers pertain to stocks but are applicable to many different types of investments.
1. Small investors usually don't know anything about their broker.
"They don't take the same kind of care they would if they were buying a house or a car," said Robert Fisher, vice president and resident manager of Drexel Burnham Lambert Inc.'s Los Angeles office.
Fisher suggests asking a potential broker for references and client recommendations. Before you buy a single share of stock, he also suggests a face-to-face meeting to establish a rapport.
"The biggest mistake is to go with the broker who promises the highest return," said Philip C. Hallenbrook, a senior broker with Dean Witter Reynolds Inc. in Beverly Hills. "There is no monopoly on brains in Wall Street. Do your research and find a qualified broker in a good firm who can assist you in the achievement of your goals."
2. Small investors fail to determine exactly how much money they are prepared to lose.
All the brokers said it is imperative to set a "risk tolerance," whether it be 10% of your initial capital or 25%. "Can you lose 10% and still sleep at night?" Drexel's Fisher asked.
3. They lack patience.
Greed forces many small investors to buy and sell too quickly when the real profits may come from holding on to a stock. "Investors often fail to allow profits to run. Don't take your money out too early," said David P. Zetterstrom, vice president for investments for Paine Webber Inc. in Beverly Hills.
4. Many small investors make the mistake of selling the winners and keeping the losers.
"This is called the kennel investment plan," said Dean Witter's Hallenbrook. "At the top of the market you end up with all the dogs. Weed out your investment mistakes early and redeploy the capital into good stocks."
5. Too many investors fail to review confirmation letters and correspondence from their brokers.
If this unopened mail is stuffed into desk drawers, people run the risk of losing money or finding out that their broker purchased the wrong stock.
Confirmation letters are designed to protect the investor from a broker's errors. Moreover, they can tip an investor to
excessive trading in his or her account at the hands of an unscrupulous broker. Churning, as the practice is called, generates a lot of brokerage fees, but the client can end up losing capital.
6. Small investors mistakenly believe that heavy trading will increase their profits.
"Trading is a loser's game," said Drexel's Fisher. "It really becomes more like Las Vegas than investing. Be patient, buy quality."
7. Many investors fail to rely on good research--including their own.
Even the most inexperienced investor can read a company's annual report or an industry analyst's research report. Investors should be knowledgeable about the products and financial history of the companies they invest in. To keep track of an investment, learn how to read stock tables and other financial listings in the daily newspaper.
8. Too many investors wrongly put tax considerations ahead of other factors.
"It's a mistake to put tax considerations first," said Dean Witter's Hallenbrook. "Use tax planning as a guide, not a god. Put your energy into making good investment decisions and if you have to, pay the taxes and smile."
9. Many investors err either in overconcentrating assets in a single area or overdiversifying.
"Over a long period of time, a balanced, diversified portfolio will normally provide higher returns than investing in one tier of the pyramid," said Paine Webber's Zetterstrom.
Zetterstrom tailors an investment pyramid to each client's needs. Generally, he recommends placing 70% of assets into very secure investments such as certificates of deposit, insurance or AAA-rated bonds.
The next tier would include 10% to 15% of assets invested in high-quality stocks or investment-grade bonds. An additional 5% to 10% of assets could be allocated to a speculative tier, perhaps invested in over-the-counter stocks, high-technology firms and so on.
The final tier may include 5% of assets invested in the highest risk areas--options, precious metals or commodities.
10. Many small investors fail to adjust to a changing market.
Investors must ask themselves and their brokers how a particular investment is affected by inflation, recession, dollar devaluations, etc. It pays to stay on top of the news.