Daily Gains Letter

Top-Three Critical Mistakes Investors Make

By for Daily Gains Letter | Apr 1, 2013

010413_DL_zulfiqarWhen it comes to investing for the long run, investors must make sure that they make their investment decisions based on extensive analysis—not buy on rumors or “inside information.” Through thorough analysis, an investor can gain peace of mind.

If you avoid these following common investor mistakes when investing, you can be a better investor over the long run and can witness your portfolio grow.

 

Critical Mistake #1: Basing investment decisions on a company’s price-to-earning (P/E) ratio

The P/E ratio is very commonly quoted in the financial media, but at the end of the day, by itself, this ratio doesn’t really tell you much about a company’s health. In essence, the P/E ratio is simply derived by dividing the company’s price per share by its earnings per share—it’s nothing more than that.

Let me ask one question. Currently, Apple Inc (NASDAQ/AAPL) trades just above $450.00 with a forward P/E of 9.09. (Source: Yahoo! Finance, last accessed March 27, 2013.) How does the company’s financial health look?

In order to make a better investment decision, you must look at other measures as well. By doing this, you can know how the company is doing and how efficient it really is in its business.

 

Critical Mistake #2: Taking high risk to make higher returns

It is true that the more risk an investor takes, the higher their returns are going to be. But investors who are investing for the long run must realize that this can kill their portfolio in a very short period of time.

By using proper risk management and capital preservation techniques, you can grow your portfolio exponentially over time. Just look at some of the biggest companies featured on key stock indices today; at some point, those same companies were trading at low prices even though they’re significantly higher now. Consider Bank of America Corporation (NYSE/BAC), for example. In the midst of the financial crisis, the shares of this company traded below $2.50. Now, the company’s shares trade above $12.00—an increase of more than 380% in a matter of a few years.

Bank of America is just one example; there are many other opportunities where investors can make healthy returns. You don’t have to take high risk—you just need time to grow your portfolio to new heights.

 

Critical Mistake #3: Buying low and selling high

In theory, the buy low/sell high strategy sounds great, but the question that arises from this is: what is “low?” And what is “high?” If a stock is trading at $100.00 and it falls to $95.00, is it low? And for a stock trading a $50.00 and rising to $60.00, is it considered high?

Investors might make the mistake of considering a stock low when it’s still falling or consider it high when the price is increasing. Instead of buying when a certain stock is falling or selling when it is appreciating, you should assess the fair value of that stock. Remember, the stock market moves on expectation, and certain stocks move on how well they are going to perform.

Considering these three critical mistakes when you make any investment decision will make you more aware of your performance, keeping you from buying into the hype. In addition, your decision will be based on actual research, and not just make-believe “information.”

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