New investors are bombarded with advice from everywhere. Financial television, magazines, websites, financial professionals, friends and family members all have advice on how to structure your investment portfolio. Beginning investors are much more likely to give credence to investment tips than experienced investors. While the advice is meant to be helpful, it may actually be detrimental to the investment newbie. (For more, see Investing 101: A Tutorial For Beginner Investors.)
Here are five examples of the types of dangerous advice given to beginning investors:
1) "Buy Companies Whose Products You Love"
How many times has someone told you that when investing, you should buy companies that make products you love? This can be a risky and expensive proposition.
For example, let's say you want to buy shares of Apple because you love your new iPhone 4G. You buy shares of Apple at its market price and wait to reap the rewards from all of the iPhone sales. The problem with this strategy is that it fails to take price into consideration. Apple may be a great stock to buy at $200, but it could be a pricey investment at $300.
New investors tend to overpay for companies that they really want to own. This buy-at-any-cost philosophy can leave you regretting your stock purchase at the end of the day.
2) "Invest In What You Know"
Investing in what you know is an old investment axiom. This works well for experienced investors who are familiar with lots of companies in different sectors of the economy. This is terrible advice for the investing novice, because it limits your investments to only businesses that you know a lot about.
What if the only companies you know about are in the restaurant industry or retail industry? You may find yourself overinvesting in one or two sectors. Not to mention the fact that you would end up missing out on some great companies in the basic materials industry or technology sector. (Evaluate the past performance before investing in technology sector gadget funds; read Technology Sector Funds.)
3) "Diversify Your Stock Portfolio"
Diversification is supposed to help protect your portfolio from market drops and control risk. It's a great concept, but proper diversification can be difficult to achieve and expensive to do. New investors have difficulty building a properly diversified portfolio because of the costs. If not using an index fund to diversify, constructing a properly balanced portfolio in stocks requires thousands of dollars and may require buying at least 20 individual stocks. (For more on index funds, read Go International With Foreign Index Funds.)
It can also be difficult for new investors to maintain a balance between being diversified and not being overly diversified. If you aren't careful, you could end up owning 50 different stocks and 50 mutual funds. An investor could easily get overwhelmed trying to keep track of such a portfolio.
4) "Trade Your Brokerage Account"
Since the market crash of 2008, more investors are abandoning a buy-and-hold strategy and turning to short-term trading. Financial television shows and market experts have even been recommending that investors trade their accounts. Short-term trading may work for sophisticated investors, but it can crush the confidence of new investors.
Short-term trading requires the ability to time buy and sell decisions just right. It takes lots of available cash to hop in and out of positions. It can also decimate your entire portfolio because of trading fees and bad decision making. Daytrading stocks is a strategy best left to the experts. (To dig deeper into this topic, read Buy-And-Hold Investing Vs. Market Timing.)
5) "Buy Penny Stocks"
Emails, advertisements, friends and even family members often trumpet penny stock investing for new investors. The attraction of penny stock investing is that it seems like an easy way to get rich quick, since penny stocks are subject to extreme price volatility. If shares of ABC Company are selling for $1.50 per share, you could buy 1,000 shares for $1,500. The hope is that the stock goes to $3 or more so that you could double your money quickly.
It sounds great until you realize that penny stocks trade in the single digits for a reason. They are normally very flawed companies with large debt burdens and whose long-term viability is usually in doubt. Most penny stocks are much more likely to go to zero than to double your money.
The Bottom Line
As you can see, sometimes investment tips can do more harm to your portfolio than good. One size fits all may work for ponchos and raincoats, but it does not work when it comes to investment advice.
Catch up on your financial news; read Water Cooler Finance: The Unrelenting Claw Of Bernie Madoff.