Avoid these common blunders

November 8, 1999

Here's what to guard againstplus what you need to know to choose the right course.

Avoid these common blunders

Jump to:Choose article section...My Best Financial Move

Here are six investment goofs to guard against, plus adviceto set you on the right course.

By Leslie Kane, Senior Editor

Investing's easy: Pick up a phone or log onto the Internet, and you canbuy stocks, bonds, and mutual funds with lightning speed. But investingwithout detective work and a heavy dose of skepticism invites big mistakes.

Physicians seem particularly prone to such errors. "Doctors areused to life-or-death decisions, so when a broker calls or a colleague offersa deal, they often act quickly," says E.W. "Woody" Young,a financial adviser with Quest Capital Management in Dallas. "Physiciansalso tend to be risk takers, so they're sometimes less cautious than theyshould be.

"Many doctors haven't learned to evaluate a business propositionor identify factors that contribute to a company's success," adds Young.And physicians who see their incomes declining sometimes panic and try tomake up the shortfall through risky ventures, he notes.

We asked several financial experts to describe some of the more commonblunders investors make. Don't count on dumb luck to rescue you from thesemissteps:

Ignoring investment expenses. Mutual funds dock you in a variety of waysthat drag down returns. For instance, many funds charge loads--sales commissionspaid up front or deferred until you redeem your shares. A hefty load affectsyour account balance for years. Say you put $50,000 into a no-load fundand the same amount into a fund with a 5.5 percent initial sales charge.If both portfolios return 12 percent annually, after 10 years you'll have$155,292 in the no-load fund and $146,751 in the load fund (disregardingother fund expenses, which we're about to discuss).

For a truer picture of a mutual fund's annualized returns, check itsload-adjusted performance. You can find it in Morningstar Mutual Funds,which is available in most libraries, or you can ask your financial adviseror broker for this information.

In addition to loads, watch out for hidden fund expenses like re-demption,management, and 12b-1 marketing and distribution fees. The expense detailswill be listed in the fund's prospectus. But you have to read it to findthem. "Investors rarely read the prospectus or look at a fund's ongoingcosts, and they don't realize the performance hit they take when expensesare high," says Gary R. Greenbaum, an investment adviser in Oradell,NJ.

An easy way to assess a fund's overall cost is to look at its expenseratio, which shows the percentage of assets deducted to pay the fund's billseach year (excluding loads and brokerage fees). Generally, index funds havethe lowest expense ratios; the average is 0.65 percent. Actively managedfunds, on the other hand, are almost always more costly to run, becausethe portfolio manager is constantly investigating, buying, and selling sharesof companies.

Expenses can also vary by the type of fund. For example, the averageforeign stock fund's expense ratio is 1.70 percent, compared with 1.43 percentfor a domestic equity fund. Again, with a publication such as MorningstarMutual Funds or The Value Line Mutual Fund Survey, you can compare a fund'sexpense ratio with those of other funds or with a category benchmark.

In general, you're better off choosing a no-load fund with low annualexpenses. Still, never buy based on these factors alone. Consider the fund'slong-term returns and how well it diversifies your portfolio.

Putting too much faith in your broker. Whether or not you profit froman investment, your broker earns money selling it. Many brokers are responsible,but others push sales just to make a buck.

One New York plastic surgeon learned that the hard way. His broker hadput the doctor's $100,000 into more than 40 mutual funds with high frontloads. The broker also sold him odd lots of bonds, which carry higher transactionfees than round lots of 100.

Even brokers with the best intentions can make decisions that prove badfor you. "Often, your broker doesn't know your tax bracket, cash flow,risk tolerance, and financial targets, so he can't evaluate whether a particularinvestment fits your goals," says Greenbaum. "Worse, some doctorswork with several stockbrokers, none of whom has the total picture. That'swhy it's wise to prepare a written investment policy statement to documentyour overall strategy."

Review your broker's recommendations carefully. If he suggests what soundslike an unwise investment, have your accountant or financial planner checkit out. If he repeatedly makes bad calls, get a new broker.

Freaking out over short-term price movements. Stocks move like a sailboattacking back and forth to go forward. Investors sometimes watch their holdingstoo closely and panic at these normal gyrations.

"Some doctors buy or sell depending on the last quarter's returns,"says Brian Grodman, (above), a financial adviser in Manchester, NH. He'sreminded of the emergency room physician who last year bought Bank One atabout 60 per share and General Electric at 100.

Both companies stumbled temporarily, Grodman says. The doctor becameupset and sold the stocks months later, for less than he paid for them.Both then recovered.

You're better off buying stock in sound companies and holding it foryears, Grodman advises. If earnings remain strong, periodic fluctuationswon't be too unsettling.

Even if you're a risk taker, you could find yourself tempted to sellwhen it might be better to hold. Before you make a decision you may laterregret, compare the performance of your mutual fund or stock against thatof its appropriate benchmark. For example, if you bought a large-cap growthstock or fund, look at the Standard & Poor's 500 Stock Index. If youown small-caps, refer to the Nasdaq Composite Index or the Russell 2000Index. You can find both indexes in The Wall Street Journal or posted ona financial Web site such as CNNfn (www.cnnfn.com). If your stock or fund is pacing its index, hold tight.

Investing before doing your homework. Paul M. Reinbold, an internistin Cambridge, MD, learned the value of research after investing in two high-flyingstocks based on a television reporter's one-minute recommendation.

"About four years ago, I put $3,000 into XCL Ltd., an oil-explorationfirm that has rights to drill in China," Reinbold recalls. "However,the company hasn't yet barreled any oil, and my investment's now worth about$150.

"I also invested $4,000 in SubMicron Systems, a company in Allentown,PA, that makes automated equipment used in the fabrication of semiconductors.Apparently the company had problems with the equipment, and now my stakeis worth less than $100."

Ouch. These days, if Reinbold's interested in a stock, he does some research.He starts by getting the company's annual report. You can do the same thingover the Web, at the FreeEDGAR Web site (www.freeedgar.com), or by calling the company's investor relations department. Reinbold alsobuys a copy of the Standard & Poor's Stock Report on that company, whichgives an S&P analyst's evaluation and recommendations as well as keystatistics.

Like Reinbold, a Texas gastroenterologist got burned by doing too littleresearch. He bought $50,000 of stock in a company that had invented a technologydesigned to begin chilling a beverage the instant someone opened its aluminumcontainer.

"The doctor felt that he had fully investigated the company, becausehe had spoken to its president about marketing plans," says financialadviser Woody Young. "Within months, the company went bankrupt, andthe doctor lost his money."

Before making any sizable investment, ask the company for an auditedfinancial statement. If it doesn't exist, beware. "A good idea isn'tenough to make a company a success," says Richard K. Hammel, a financialadviser from Brentwood, TN. "Look at the company's assets and managementexperience. Make sure cash flow is positive. It's a bad sign if most ofit goes to cover overhead; you want ample cash to go toward operations thatwill build the company."

In the early '80s, Stephen N. Ewer, a cardiologist from Kennewick, WA,jumped at a broker's phone solicitation. He paid $1,300 for silver coinstouted as collector's items that would appreciate in value. "A yearlater, the company that issued the coins was indicted for securities fraud,and my investment's now worth about $400--the value of the silver,"Ewer says. "Sometimes I still cart the coins around in a leather bag,as a reminder not to make mistakes like that again."

If an investment requires physical labor on your part, not just a cashinvestment, speak to others who've tried it. One such venture laid an eggfor a Texas surgeon. He'd read that emu meat was low in cholesterol andwas gaining popularity. He spent $100,000 a couple of years ago to buy aherd of the large Australian birds, plus equipment and feed. When some emusgot sick, and the hens didn't lay eggs, he shelled out another 100 grandto keep the herd alive.

Emu meat prices have since dropped. The doctor can't afford to maintainthe 120-pound birds and can't find anyone to buy them.

"He should have learned more about the mechanics, costs, risks,and work involved in raising emus, and whether the market had peaked orwas growing," says Young. "Essentially, he lost his investment.At this point, he'd like to shoot the birds."

Failing to diversify. You need a variety of holdings to protect yourcapital in case one asset class sinks. "That's the single biggest keyto your portfolio's success," says Hammel.

One physician had almost half of his $300,000 portfolio in three drugcompanies' stock, and the remainder in Treasury bills. If the pharmaceuticalindustry or those particular companies declined, he'd take a big hit. Herefused to sell any of the drug stocks, which were doing well, but he tookhis broker's advice to diversify by adding mutual funds and stocks of financial-servicesand equipment-manufacturing companies to his portfolio.

"You should be invested in seven or eight industries," saysEdward M. Haberer, a financial adviser in Cincinnati. "A sensible allocationmight be 70 percent stocks for an aggressive or young investor, and 50 percentfor a conservative investor. Hold the rest in bonds and perhaps some realestate."

Four or five mutual funds can create a well-diversified portfolio, saysHaberer. "Include large-, mid-, small-cap, and international funds,plus bonds. If you own more than six funds, you probably have a lot of overlappingholdings."

Timing the market. A plethora of newsletters written by market timersclaim to tell you when the market will peak and fall. Some investors swearby these newsletters or follow technical analysis, which attempts to predictstock movements based on charts of past activity. Market timers seek toyank their money out of the market just before a plunge and buy when pricesare in the trenches.

"There's no science to market timing," says investment adviserGary Greenbaum. "Although it may be fun to follow, and it gives yousomething to talk about at a cocktail party, most timing 'experts' don'thave an impressive track record. You're more likely to buy and sell at thewrong time."

A University of Michigan study shows that during the 31 years from 1963through 1993, if you were out of the stock market during the 90 best days,you'd have missed 95 percent of the market's gains. A dollar invested in1963 and not touched would have grown to $24.30, but without those 90 days,it would have grown to only $2.10.

My Best Financial Move

"I started buying Intel stock in 1995, after the company settledthe patent dispute over its Pentium chips. I'd read everything I could aboutthe controversy, and had decided that the company would ride out any lingeringeffects and emerge stronger than ever. Since then, my shares have splitseveral times, and my initial investment and reinvested dividends have grownto more than $58,000. That's an average annual return of more than 50 percent.

"So now I don't automatically dismiss stocks that are troubled;in fact, I try to buy good companies when they're down."

--Pinjai R. Ravichander, MD

Leslie Kane. Avoid these common blunders. Medical Economics 1999;21:86.