While modern-day investing can't be considered easy, it's not necessarily difficult either. The secret to success is usually just avoiding the small mistakes that end up costing big bucks.
With this in mind, here are the five most common pitfalls investors should make a point of avoiding no matter how tempting the alternative looks...
1. "Conceptual" investing
Investors love great stories. After all, it's fun to be able to say you own the hippest dot-com stock, or you're invested in the biotech stock that's working on a cutting-edge treatment for cancer. But there's a problem with focusing on a general theme and ignoring everything else. Eventually, bills have to be paid. Unless the investment idea actually bears a decent amount of fruit compared to what the stock costs, then what's the point?
Conceptual investing ran rampant in the dot-com era in the late 1990s and early 2000s, and ultimately crushed many investors.
Take eToys.com for instance. The toy-selling website launched in 1997 and was all the rage, following in the same footsteps as Amazon.com (Nasdaq: AMZN), and competing with Toys R Us (and the Toys R Us website). The fact that the website was focused on one market was a big hit with investors who never asked why the company's losses were growing alongside the top line. By 2001, however -- and thanks to $247 million in accumulated debt -- the company was forced into bankruptcy, having never actually made a dent in Amazon's sales.
2. Not selling
Warren Buffett frequently says his favorite holding period is "forever," meaning he never buys a stock he thinks he might have a reason to sell at some point in the future. It's his quaint way of suggesting investors think long and hard before becoming a stakeholder in any company. The problem is, he may say one thing, but he does another.
Buffett does sell his holdings, mostly when the position's maximum value has been priced in, as was the case of his holding in Intel (Nasdaq: INTC). Though the Oracle of Omaha only stepped into his position in late 2011 at an average price of less than $22 per share, he sold his stake in May of last year at $27.25 a share. The exit locked in a short-term gain of 24%, which was a brilliant time to take profits, in retrospect. The stock currently trades at roughly $21 a share.
The quick lesson in this story is: If a stock can be priced low enough to make it a "buy," then by the same line of reasoning, it can be priced richly enough to make it a "sell."
3. Lack of consistent approach/chasing hot trends
Remember the old cliche, "Even a stopped clock is right twice a day?" It's a bit of a back-handed compliment, omitting the obvious fact that a stopped clock is still wrong the other 23 hours and 58 minutes a day. Yet, at least by doing nothing, that clock is still occasionally correct. But if the clock's owner was randomly swinging the hour-hand and minute-hand around at various times of the day, then it would probably never be right. Traders who jump from one approach to another at the drop of a hat are also apt to miss out on ever being right for reasons other than pure luck.
4. Trading binary events
It's unfortunate that many investors' first foray into the market is with a trade that's effectively a coin toss. If the news is good, then the stock might soar and the trader reaps a big reward. If the news is bad, then the trader is left holding the bag and can lose a lot of money in a matter of seconds.
It's called a binary trading event, or a piece of impending news that can only have one of two possible outcomes -- either a very bullish one or a very bearish one -- no in-between. It's also an approach investing heroes such as Buffett, Benjamin Graham and Peter Lynch wouldn't use in a million years, simply because there's too much risk and no way of hedging it. These market veterans pick stocks that give them multiple ways to win in multiple timeframes. With a binary event, there's only one way to win -- once.
The most common binary event trades come from the world of biotech, and usually surround a drug's approval (or lack thereof). Guessing wrongfully can be far more painful than it's worth though. As an example, shares of InterMune (Nasdaq: ITMN) plunged 80% when the Food and Drug Administration rejected the company's highly-touted lung disease drug Esbriet.
This kind of risk is rarely worth it.
5. Underestimating the power of income and dividends
Growth stocks and big gains are what investing dreams are made of, but these dreams don't always pan out nearly as often or nearly as well as initially hoped. The fact of the matter is, income and dividends may not seem sexy, but a full 40% of investors' long-term gains are the result of dividends rather than capital appreciation. Throw in the fact that dividends are consistent while price appreciation can be erratic, and some investors might start to wonder why they bother with growth stocks at all. The best way to build your portfolio for long-term growth is with Retirement Savings Stocks, which you can learn more about here.
Action to Take --> Avoiding all five pitfalls just seems like a matter of applying common sense when talking hypothetically, but they're not as easy to recognize when it comes time to make decisions about how real dollars should be allocated, especially when it comes to your retirement portfolio. Investors who can see when they're about to fall into one of these five traps, however, stand to outperform the majority of their investing peers.You should always look for safe income, that's why Retirement Savings Stocks are always a great addition to any portfolio.