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Look Before You Leap!
As much as we’d like to think otherwise, we all
make mistakes. Unfortunately, when we err with our investments, it adds up to less money at the end of the day.Successfully growing your wealth, then, involves both making the right moves as well as avoiding the wrong ones.
In addition to recommending what I believe are the most promising investments every month in Profitable Investing, I
also want to help you avoid costly mistakes.Here, then, are the five biggest potential blunders I see investors in danger of making right now.
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Investing Mistake #1: Staying entirely out of the stock market for fear of another leg down.
This is the granddaddy of them all. I believe the biggest mistake you could make is to give up entirely on the long-term growth
you can only get by investing in stocks.Unfortunately, that’s what happens in bear markets. As they wear on, they wear on investors’ nerves, too. People grow more and
more pessimistic, sell more and more stocks — and eventually decide to abandon equities “forever.”That’s usually just about at the bottom, which I think we probably already saw in March. If you’ve sworn off stocks because
of recent losses, I encourage you to rethink your position and avoid this potentially fatal error.
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Investing Mistake #2: Leaving cash in zero-yield T-bills or money market funds when numerous FDIC-insured online banks are paying significantly more.
Cash is your best shelter in a market storm — even
better than gold, because the price of
bullion can fluctuate wildly and unpredictably. Investors of all ages, including retirees, should set aside a portion of their
income to build a cash kitty. I suggest keeping at least six months’ worth of living expenses in cash at all times; three years’
worth if you’re retired.In today’s unsettled environment, I prefer to squirrel the majority of my cash in a place where people always used to stash
cash
— the bank. Banks are still failing, even though it appears the worst of the financial crisis is behind us, so be sure you
open accounts that are FDIC insured. I recommend opening as many bank accounts as you need to stay within the boundaries of FDIC
insurance: $250,000 per depositor ($500,000 for joint accounts).GMAC Bank has long been one of my favorites. It is now called Ally Bank and is paying 2% in its online savings account.
That’s hardly a bonanza by the standards of the 1980s or 1990s, but it’s several times more than what the U.S. Treasury is paying
on one-year bills!
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Investing Mistake #3: Holding leveraged ETFs for more than a brief trade.
Leveraged exchange-traded funds, an increasingly popular investment,
are designed to return double or even triple the movement in a specific index, be it a broad index such as the S&P 500 or
a more specific sector such as the energy
sector or financial sector.I have no problem with these if you are willing to accept the risk and volatility, and as long as you don’t hang on to them
for too long. Why? After a couple of weeks, their financing costs start to eat you up.Here’s a good example: One leveraged ETF that we’ve talked about recently in Profitable Investing is the ProShares
UltraShort S&P 500 Fund ().This “double bear” exchange-traded fund is an inverse fund, designed to return approximately 2% on days when the S&P 500
index falls 1%. Over the long run, because of the cost of financing the fund’s short positions, the 2:1 advantage gradually erodes,
even in a falling market. And, of course, if the market continues to rise, the fund’s share price will drop approximately twice
as fast as the S&P.If you’re inclined to trade them separately, just make sure you don’t hold them for too long in an attempt to make up some of
the money you may have lost. It will end up costing you in the long run.
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Investing Mistake #4: Betting heavily on runaway inflation via gold or Swiss francs.
When you think about it, it’s kind of loony that people are fretting about runaway
inflation right now. Consumer prices over the past year have fallen for the first time since 1955.I agree that the Fed’s bailout operations could lead to inflation down the road, but that’s an issue for 2010 and beyond, not
today. It’s going to take a surprisingly long time for the government’s bailout efforts to rev up the economy enough to stimulate
inflation.We just aren’t going to swing overnight from a deflationary recession to an inflationary boom. Indeed, there’s little evidence
that business activity, here or in any other industrialized country, has truly bottomed yet. Investors who are buying gold as are a couple of years early, at least.Even now, I think you should be buying oil-related
investments on pullbacks, because the long-term supply/demand picture is very bullish for “black gold.” Yellow gold can probably
wait a while longer. If anything, I would be looking for a chance to short gold and other inflation hedges should they climb
further.
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Investing Mistake #5: Sticking with mutual fund managers who still don’t “get it” that we’re in a new era of slow growth, crippled banks reluctant to lend and pinched consumers reluctant to borrow.
You don’t need me to tell you it has been a tough stretch for many mutual fund managers. Even some of the greats, with the finest
long-term track records, stumbled.And that’s precisely what makes it tricky to decide which mutual
funds to hang on to, and which you should cut loose. You don’t want to get rid of a fund if the manager is about to come
roaring back to glory. On the other hand, if recent bad performance reflects a fundamental problem that may linger for years,
it’s time to bail.Some funds, sad to say, just aren’t worth keeping. It’s not simply a matter of poor performance or high expenses. You should
also sell a fund if the manager is taking reckless risks: concentrating a huge percentage of the fund in one industry or “doubling
down” on stocks that have collapsed in price since the fund first bought them.I’m wary, too, of managers who refuse to acknowledge their mistakes. If a fund manager insists that his or her analysis of a
company that hurtled into bankruptcy was “fundamentally on target,” I have to question whether that person is capable of basic
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